The economic scenario viewed here as most likely involves the current "soft patch" in global industrial activity continuing into the autumn but falling short of a "double dip", with a revival of momentum following in early 2011. Recent news seems consistent with this script.

The first chart below shows six-month growth rates of G7 plus emerging E7 industrial output and a composite leading index derived mainly from OECD country indices. A "leading indicator of the leading index" is also plotted, based on its shorter-term momentum.

The leading index itself continued to slow sharply in August and its recent weakness is now being reflected in industrial output. The double-leading indicator, however, moved up from zero, suggesting that six-month growth in the index will bottom at this level within the next couple of months, with output itself following around end-2010. The rise was marginal but the indicator is a smooth series and usually gives reliable signals of turning points.

An upturn from late 2010 would be consistent with recent better G7 monetary trends: six-month growth in real M1 troughed in January 2010 and led the leading index and industrial output by 8-9 months and 11 months respectively at the last two turning points – see previous post. Available September figures suggest that the real M1 pick-up has been sustained, although the rate of expansion is much lower than in late 2008 and early 2009 – second chart.

What could go wrong? QE2, arguably, poses the greatest risk – any direct economic boost from a further monetary injection is likely to be outweighed by associated strength in commodity prices, which will cut real incomes and increase pressure for E7 policy tightening. Optimists should hope that the Fed reins back on its plans – markets would suffer a short-term setback but the price would be worth paying for a more stable economic outlook.

Regular pay rose by an annual 2.3% in August, the fastest for 15 months. A measure of total pay growth, incorporating a 12-month moving average of bonuses, was 2.2%, a 19-month high – see first chart.

The annual rates of change of regular and total pay bottomed in late 2009 a few months after the retail prices index (RPI), which had been pushed down by interest rate cuts, house price falls and the temporary reduction in VAT. Current pay growth remains unusually low relative to RPI inflation, suggesting a further increase. Bonuses, in particular, could strengthen further, given buoyant corporate profits.

Elsewhere in today's labour market report, job vacancies fell further in September, suggesting that the recent recovery in employment will stall. A more positive message, however, emerges from the latest Monster survey of on-line recruitment activity: the employment index, which correlates with and may lead the official vacancies series, rose further last month – second chart. (The survey measures opportunities posted on corporate career sites and job boards, including Monster. The index levels in the chart have been seasonally adjusted.)

QE2 is damaging global economic prospects as an associated rise in commodity prices squeezes real incomes and forces central banks in emerging economies to tighten policies.

China's decision this week to raise reserve requirements temporarily for six large commercial banks suggests that another phase of restriction is beginning in response to economic reacceleration, rising industrial cost pressures and soaring food prices – see previous post.

Based on recent gains in the weekly food produce price index, the CPI food component could rise by about 3% between August and October – see chart. Since it was little changed between August and October 2009, this would push the annual increase up from 7.5% to more than 10%. With food accounting for one-third of the CPI basket, this, in turn, implies that headline inflation could rise from 3.5% in August towards 4.5%.

CPI inflation was stable at 3.1% in September but may rise towards 4% over coming months, reflecting surging commodity prices and the VAT hike. This would squeeze consumer budgets, thereby increasing the risk of a "double dip", while making it difficult for the MPC to launch QE2. There is a strong case for postponing the VAT increase until external inflationary pressures ease.

Key factors suggesting a rise in inflation include:

• VAT pass-through. The planned hike in the standard rate from 17.5% to 20% in January 2011 follows a rise from 15% this January so might be expected to have little impact on annual inflation. The Bank of England's regional agents' survey, however, suggests that most firms plan to pass on the increase in full, in contrast to the 2010 rise (which was a reversal of a temporary reduction). Assuming that pass-through was 50% this year and will be 90% for the coming hike, the annual CPI rate would be boosted by 0.6 percentage points.

• Food prices. A post a month ago suggested that CPI food inflation would rise to an annual 7% but a further substantial increase in commodity prices in recent weeks could result in a move to 10% (below the 14.5% peak reached in 2008). From 4.9% in September, this would add 0.5 percentage points to headline inflation, given food's 9.6% weight. Additional upward effects are possible via the beverages and catering services CPI components.

• Household gas bills. Ofgem recently estimated that energy suppliers' gas purchase costs would increase by 13% by next spring, based on higher forward prices. The impact on household gas bills is unclear but a 10% rise, in contrast to a 5.7% cut over the last year, would add 0.4 percentage points to annual CPI inflation, given a 2.5% weight.

• Motor fuel prices. Fuel cost inflation has fallen significantly since the spring and should decline further as price hikes in late 2009 and early 2010 drop out of the annual comparison. Pressures are reemerging, however, with a recent rise in wholesale costs, on top of this month's duty increase, suggesting that a litre of unleaded will return to about £1.20, from £1.15 in September. Fuel inflation, therefore, will subtract less than previously expected from the headline CPI rate – an estimated 0.3 percentage points by early 2011.

In combination, these factors imply a boost of 1 percentage point or more to annual CPI inflation by early next year. A rise, therefore, looks inevitable, even assuming some slowdown in other CPI components.

One further point: CPI inflation continues to be suppressed by a suspiciously-low estimate of clothing and footwear price rises. While the RPI clothing and footwear index rose by an annual 9.4% in September, the corresponding CPI increase was just 0.9% – National Statistics, in effect, assumes that consumers are so expert at shopping around that they are able to buy the same volume for just 0.9% more than a year ago despite a 9.4% increase in label prices.

The household survey measure of US non-farm jobs, adjusted to exclude temporary census employment, rose by 132,000 in September to a 14-month high – see first chart. This may be a better guide to employment trends in the early stages of an expansion than the alternative payrolls survey measure, since it captures jobs created by start-ups. The household measure has gained 617,000 over the last six months versus a 433,000 increase in payrolls jobs.

Within the payrolls report, private-sector jobs rose by 64,000 in September. Further gains are likely, judging from a continuing recovery in job openings (vacancies), which lead employment – second chart.

Euroland monetary trends are consistent with an ongoing, but slower, area-wide economic recovery. A big divergence, however, has opened up between core countries and the beleaguered periphery.

Narrow money M1, comprising currency in circulation and overnight deposits, is usually a better economic leading indicator than broader measures. The first chart shows six-month growth of M1 (i.e. overnight) deposits for Euroland as a whole and core / peripheral groupings. (There is no country breakdown of the currency component of M1. The country figures for deposits refer to holdings by Euroland residents at domestic banks.) Area-wide expansion has slowed but was still a solid 3.5% in August, or 7.1% annualised. This, however, conceals continued strong growth in the core – defined here as Belgium, France, Germany and the Netherlands – offset by contraction in peripheral countries – Greece, Ireland, Italy, Portugal and Spain.

M1 deposits warned of the recession, sliding in both the core and periphery from late 2007 ahead of a fall in Euroland GDP in the second quarter of 2008. A synchronised recovery, meanwhile, from late 2008 foreshadowed a rise in GDP beginning in the third quarter of 2009. Recent core / periphery divergence is unprecedented and dates from the escalation of the sovereign debt crisis in early 2010.

Part of the explanation is that money-holders in peripheral countries have transferred funds to foreign banks perceived to be safer, either because of less exposure to bubble excesses or implicit backing from governments with stronger fiscal positions. The economic implications, though, are still negative – deposit outflows have tightened monetary and credit conditions and money held abroad is less likely to be spent on domestic goods and services.

A country breakdown shows that weakness has been most acute in Greece and Ireland, with Italy relatively resilient – second chart. Spanish trends have deteriorated sharply, with deposits contracting at a similar pace to that preceding the recession.