The Spanish government projects GDP expansion at a still-solid 3.3% in 2008, an election year. This looks optimistic based on recent monetary trends. As the chart shows, annual growth in real narrow money (“cash and cash equivalents”) has fallen steeply this year. After a similar plunge in 2000-01 GDP growth dropped to just 2.7% in 2002.

Housing prospects are worse now than in 2001-02. The Spanish boom has been much bigger than its US equivalent. The share of residential investment in current-price GDP stood at 4% in both countries in 1995. It peaked at over 6% in the US in 2005 but is now over 9% in Spain. Leading indicators look ominous: approvals for new housing fell 28% in the three months to July from a year before.

With downside risks mounting, government plans to ease fiscal policy look timely, albeit motivated mainly by electoral considerations. However, it is doubtful such action can substitute for interest rate relief, which is likely to come much too late for beleaguered housebuilders.

I have been betting against gloom-mongers on economies and equity markets partly because of the strength of global money supply growth – see here. G7 inflation-adjusted broad money rose by a bumper 7.6% in the year to August.

A useful summary measure of global liquidity conditions is the difference between real money and industrial output growth. A positive gap may imply there is “excess” money available to flow into markets and / or stimulate additional spending. Conversely, major financial crises have usually been signalled by money growth falling below output expansion, indicating deficient liquidity – see chart.

With money supply accelerating but industrial activity slowing, the gap has risen to a five-year high. Tighter credit conditions should constrain bank lending growth over coming months, causing monetary expansion to moderate. Any deceleration is likely to be greater in real terms, with inflation rates set to firm on the back of recent higher energy costs. Even so, the money / output growth gap should remain significantly positive until well into 2008. It is far too early to become bearish on liquidity grounds.

The key near-term risk for equities is not tighter liquidity but economic weakness and a collapse in earnings. Visibility on economic trends is still low but recent news has been generally reassuring.

Our MPC-ometer forecasts the Monetary Policy Committee vote each month based on a small number of economic and financial variables. The model suggests a 7-2 decision for unchanged rates at this week’s meeting (two votes for a 25 b.p. cut).

All 56 economists polled by Reuters last week expected rates to be held this month but 12 forecast a decline in November. Some of the doves are drawing a parallel with 1998, when the MPC raised rates in June but cut them in October, partly in response to a financial crisis. Further substantial reductions followed.

I think the comparison with 1998 is flawed for three reasons. First, the economy looks stronger now than then. GDP was estimated to have grown by only 0.5% in the first and second quarters of 1998, compared with 0.8% per quarter in the first half of this year.

Secondly, the 1998 financial crisis hit confidence hard. Business and consumer surveys weakened sharply and the stock market fell 25% from peak to trough. The latest surveys show a modest impact from recent turbulence, while the decline in stocks has been limited to 13%, with much of the ground subsequently recovered.

Thirdly, inflation risks look higher now, with businesses attempting to lift prices and broad money growth booming. The latest CBI industrial survey shows a balance of 16% of firms planning to hike prices, compared with 17% planning to cut in September 1998.

I am still inclined to think that rates are on hold until year-end, though will be guided by the MPC-ometer. Looking further ahead, the scope for reductions appears much more limited than in 1998-99.