The G7 monetary base – currency in circulation plus bank reserves – contracted further last week, as a large fall in the Eurozone offset a rise in Japan. The base is at its lowest level since December – see chart.

Markets have rallied on hopes of a large QE2 liquidity injection and may correct if this is not delivered soon and on the expected scale.

There is an outside chance that the MPC will surprise markets with a further slug of QE tomorrow:

• The "MPC-ometer" – a statistical model designed to predict the monthly decision based on incoming economic and financial data – has a slight easing bias, reflecting recent weakness in business and consumer surveys and low average earnings growth. The latest reading is consistent with a further £25 billion of asset purchases. (The model calibrates this to be equivalent to an 8 basis point cut in Bank rate.)

• Eight of the nine members of the Sunday Times Shadow MPC favour more QE (although two of these individuals, bizarrely, also voted for a half-point rate hike this month). The Shadow Commitee has often mirrored MPC thinking.

• Adam Posen's decision to come out for more QE last week just ahead of the start of the October deliberations suggests that he is confident of support from other MPC members and wanted to exert pressure on waverers.

The key reason for expecting the MPC to hold back is that short-term inflation prospects have deteriorated further – a combination of high VAT pass-through, rising food and gas costs and renewed upward pressure on petrol prices could push the headline CPI rate up towards 4% over coming months. This increases the risk that more QE would boost inflationary expectations, a consideration that may weigh with the majority.

Continuing the recent run of poor inflation news, the annual rates of increase of the BRC food and non-food shop price indices firmed in September – the first chart shows the relationship with the corresponding CPI components. Higher wholesale petrol costs and the October hike in fuel duty, meanwhile, suggest a rise in the average price of a litre of unleaded back towards £1.20 – second chart.

The Bank of Japan has fired the "QE2" starting gun with the announcement of a new asset purchase programme. The details, however, are unimpressive – further study will be required before buying starts and the current intention is to purchase ¥5 trillion over 12 months, or just $5 billion per month. It is unclear, moreover, whether the monetary base impact of the programme will be sterilised.

To put the initiative into perspective, the Eurozone monetary base is likely to have fallen by more than the full size of the Japanese programme last week as banks repaid 12-month borrowing from the ECB. (Figures are released tomorrow.)

Chinese monetary base figures are available only monthly with a lag but a recent rise in the one-week repo rate suggests that money market conditions have tightened.

A previous post, meanwhile, highlighted that the US monetary base had fallen to its lowest level since January.

Despite all the talk of QE2, therefore, there has been no expansion of the global supply of bank reserves. The ECB and Chinese monetary authorities probably oppose such an increase, while the Bank of Japan is a reluctant foot-dragger.

Hopes of a QE2 boost to financial markets rest full-square on the Federal Reserve and its European satellite, the Bank of England. The close ties between the two central banks were illustrated last week by MPC member Posen's decision to break cover and call for more QE just one week after the Fed had signalled an easing bias.

Fed action is unlikely before the next scheduled meeting on 2-3 November – a long time for impatient bulls to wait. Markets buoyed by QE2 optimism may require a positive MPC "surprise" this week to sustain their recent gains.

The Food and Agriculture Organisation food commodities price index – covering meat, dairy products, cereals, oils and fats, and sugar – rose by a further 7% in sterling terms in September, pushing annual growth up to 29% from 23% in August. This suggests upside risk to the forecast in a previous post that CPI food inflation will reach an annual 7% by late 2010 – see chart.

CPI food inflation rose from 3.0% in July to 3.9% in August. A further increase to 7% would add 0.3 percentage points to headline CPI inflation, given food's 9.6% weight in the basket. The headline rate was 3.1% in August.

A further boost is possible via the "catering services" (i.e. restaurants and cafés) component, with a 9.8% CPI weight. A rise in annual inflation to 4% from 3.1% in August would add 0.1 percentage points to the headline CPI rate, for a total 0.4 point impact.

Petrol prices have dampened CPI inflation recently and base effects are favourable until next spring but crude oil prices are climbing again. So are wholesale gas costs – Ofgem this week suggested that domestic gas bills will rise by 13% by next spring, above the 5% increase assumed by the Bank of England in the August Inflation Report. With a 2.5% weight, this would boost the headline CPI by 0.3 percentage points.

The latest survey by the Bank's regional agents, meanwhile, confirms earlier intelligence that most firms plan to pass on the coming VAT hike in full. The Bank estimates that this will add more than 1 percentage point to annual CPI inflation in 2011 but the effect is likely to be felt sooner as firms front-load increases.

These developments suggest significant upside risk to the Bank's forecast that inflation will stabilise at about 3% before starting to fall next spring. A rise to 4% is possible if the various adverse effects coincide. A renewed inflation increase would make it difficult for the MPC to embark on "QE2" asset purchases; doves may wish to press their case at next week's meeting before the window for action closes.