Monetary and financial statistics for May released today are encouraging in three respects.

First, the Bank of England's proxy measure for M4 excluding money holdings of financial intermediaries probably grew respectably, following a hefty 1.0% gain in April. The Bank currently has insufficient information to produce a firm estimate but headline M4 rose by 0.2% in May and was again depressed by intra-banking-group transactions – excluded from the proxy measure. Based on available evidence, the proxy may have risen by 0.5% or more last month.

Secondly, M4 lending – excluding the effects of securitisations and loan transfers – bounced back to show 0.9% growth in May after a rare 0.3% decline in April. As with M4, the rise would have been larger but for a decline in intra-group business. At the margin, this should lessen MPC concerns that lending constraints will be a major impediment to an economic recovery. (The Bank's latest Trends in Lending survey, also released today, is gloomy but Lending Panel banks report an ongoing modest recovery in mortgage approvals and a small net rise in corporate loan facilities in May.)

Thirdly, consistent with quantitative easing improving companies' access to non-bank finance, private non-financial firms raised a net £4.1 billion from issues of bonds, shares and commercial paper in May, up from £3.1 billion in April and well above the monthly average of just £400 million over 2003-08 – see chart. Companies have raised a net £13.6 billion in these markets so far in 2009, equivalent to 2.7% of outstanding sterling bank borrowing at the end of 2008.

The Monetary Policy Committee has been encouraged by recent better economic news and a pick-up in "adjusted" M4 but retains the view expressed in the May Inflation Report that further easing is likely to be required to prevent inflation from undershooting the target over the medium term, according to minutes of the June meeting released today.

This suggests that the odds slightly favour the MPC expanding asset purchases to the £150 billion current maximum at its July meeting, while simultaneously seeking Treasury authority for a higher limit. However, the Committee could yet choose to suspend QE at £125 billion if forthcoming business surveys and monetary data show further improvement. (The Governor's Mansion House speech this evening may provide more information.)

Labour market statistics also released today continue the recent pattern of better-than-expected news. The monthly rise in claimant-count unemployment slowed to 39,000 in May, down from a peak of 137,000 in February and the smallest increase since July 2008. This slowdown should soon be reflected in the lagging Labour Force Survey unemployment measure – see first chart.

Labour demand appears to holding up better than many feared. The monthly number leaving the claimant count has risen steadily so far this year (admittedly partly reflecting some claimants exhausting entitlements), while the rate of decline of job vacancies has eased. Indeed, the 6% drop in vacancies in the three months to May is consistent with other evidence that the economy has stopped contracting – second chart.

The smaller-than-expected fall in UK annual consumer price inflation in May partly reflects the continuing after-effects of sterling's plunge during 2008, discussed in earlier posts (e.g. here). With the exchange rate recovering recently, however, inflation prospects are improving, although the MPC's forecasts are too optimistic.

Headline CPI inflation edged down from 2.3% in April to 2.2% in May but remains above target and would be significantly higher but for December's VAT cut. Assuming retailers passed on half of the VAT reduction, "true" inflation is probably 2.7-2.8%. (The CPI at constant tax rates shows a larger rise, of 3.3%, but assumes unrealistically that the cut was passed on in full.)

As well as the VAT change, slowing food and energy prices have contributed to the recent decline in the headline rate. Core trends, however, remain sticky: the annual increase in the CPI excluding unprocessed food and energy moved up from 2.0% in April to 2.1% in May and would be an estimated 2.7% without the VAT reduction (again assuming 50% pass-through).

The impact of the lower exchange rate is evident in less favourable price trends for such categories as clothing and footwear, audio-visual goods and package holidays. Currency weakness has also reduced the benefit of lower global commodity prices: a 7.8% annual rise in the UK CPI for food and non-alcoholic beverages in May compares with an increase of just 0.3% in the Eurozone.

Sterling's recent rally, however, will curb import price pressures. The chart shows annual rates of change of manufactured import prices and the effective exchange rate, plotted inverted. Import cost inflation has already slowed from an annual 15% in December to 10% in April and prices are likely to fall later in 2009 if the effective rate remains at its current level.

The MPC appears once again to have underestimated current-quarter inflation in its latest Inflation Report: the 2.25% April / May average compares with a central projection of 1.9%. The MPC was forecasting a fall to just 0.4% by the fourth quarter but is likely to revise this up in the August Report, reflecting recent higher-than-expected outturns, better economic data and higher oil prices.

The recent sharp rise in US Treasury yields may partly reflect supply pressures and investor worries about longer-term inflationary risks from quantitative easing (QE) but the key driver has been a recovery in economic momentum.

The first chart shows three-month changes in the 10-year Treasury yield and the Institute for Supply Management (ISM) manufacturing new orders index – a good summary measure of economic momentum. A positive correlation is apparent, with the recent yield surge coinciding with the largest three-month rise in the new orders index since 1983.

The relationship suggests that the direction of yields depends not on the rate of economic growth but on whether it is accelerating or decelerating. When the new orders index reached a record low of 23 last December, it was clearly much more likely to rise than fall, implying that Treasuries were high risk. The bearish case is now less clear-cut – even though the ISM index is back above 50, signalling economic expansion.

To assess Treasury market prospects, therefore, it is helpful to have an idea where the new orders index could be heading. The second chart compares the recent revival with an average of five prior recoveries from troughs when the index fell below the 40 level. (The troughs occurred in January 1958, December 1974, June 1980, January 1991 and January 2001.)

The historical pattern suggests that the new orders index could rise further to 55-60 in the short term. Interestingly, however, the average registers a peak in August 2009, treading water over the autumn before a further move up around year-end. If the current cycle follows this template, Treasuries could enjoy a short-term rally later this summer, even in the context of an ongoing economic recovery.

First-quarter flow of funds accounts released yesterday by the Federal Reserve show a further decline in non-financial companies' borrowing requirement, defined here as their "financing gap" – capital spending minus domestic retained earnings – plus share purchases net of issuance. The borrowing requirement is a leading indicator of credit spreads – see chart and previous post.

The borrowing requirement amounted to 1.5% of GDP in the first quarter, down from a high of 9.5% in the fourth quarter of 2007. In the late 1980s and early 2000s, borrowing peaked eight quarters before the high-yield spread over Treasuries. Credit has rallied much earlier in this cycle, possibly because spreads reached more extreme levels in late 2008 than in the prior two bear markets. The historical two-year lead suggests that further significant spread compression could be delayed until 2010.

At 1.5% of GDP, the first-quarter borrowing requirement was below its average of 2.3% since 1985. The further fall last quarter mainly reflected a large cut in capital spending as companies slashed fixed investment and ran down stocks. A decline in net share buying also contributed, while firms offset profits weakness by reducing dividends, resulting in stable retained earnings.

Looking forward, an end to destocking should contribute to a significant rebound in capital spending over the remainder of 2009. The impact on the borrowing requirement, however, may be offset by a recovery in profits as economic growth resumes and a further fall in net share purchases, with companies using the opportunity provided by better markets to step up issuance.

The Bank of England's Bankstats publication this month contains for the first time a table providing detailed figures for "adjusted" M4 and M4 lending – i.e. excluding banks' business with financial intermediaries ("intermediate other financial corporations"). If these series had been made available 12-18 months ago, economists and the MPC would have been better able to anticipate the recession.

The Bank was aware of possible problems with its M4 and M4 lending measures in 2007: an article in the September Quarterly Bulletin proposed a redefinition to exclude intermediaries while the November Inflation Report warned that growth rates were being inflated by the financial crisis. Since May 2008, the Inflation Report has contained a chart showing the annual growth rate of adjusted M4; this was extended to M4 lending in August last year. The fuller data set published in the new Bankstats table could, in theory, have been made available at least a year ago.

The chart shows a measure of economic momentum based on the purchasing managers' surveys – a weighted average of the services new business and manufacturing new orders indices – together with the six-month growth rate (not annualised) of real adjusted M4 (i.e. deflated by consumer prices). In contrast to the headline measure, real adjusted M4 slowed abruptly in late 2007 following Northern Rock's implosion and contracted during the first half of 2008 as inflation spiked higher. This weakness warned of serious economic deterioration at least three months before the purchasing managers' indicator fell below the key 50 level in May 2008.

The MPC reduced Bank rate in December 2007, February 2008 and again in April then held it at 5.0% until October. It is debatable whether members pay much attention to monetary trends but, had the adjusted data been available, there is at least a chance that the Committee would have cut further over the summer despite a surge in headline CPI inflation to a September peak of 5.2%. It might also have been swifter to heed external recommendations for quantitative easing.

Just as it led on the way down, the adjusted money measure also foreshadowed the recent improvement in economic news. The six-month rate of change troughed last September and has recovered steadily, currently running at about 3% – a level historically consistent with economic expansion. The purchasing managers' indicator bottomed in November last year and the recent move back above 50 appears to confirm that the economy has stopped contracting.