Annual consumer price inflation fell further to 1.8% in August but the old retail price measure rebounded to 4.1%. The gap between the two is the largest since September 2000. The recent widening mainly reflects accelerating mortgage interest costs, which are included in the RPI but not CPI. Mortgage bills rose by 30% in the year to August.

On our calculations the average interest rate on outstanding mortgages stood at 6.0% in August, up from 5.3% a year before. Based on currently quoted rates and the large number of borrowers needing to refinance expiring fixed rate deals, the average rate is likely to reach over 6.5% by early 2008 – see chart.

The surge in mortgage bills will be a significant drag on consumer spending but may result in RPI inflation remaining above 4% going into 2008. With the labour market tightening recently, the MPC will be wary of a compensating pick-up in wage settlements when the pay round kicks off early next year.

Some economists are starting to talk about rate cuts before year-end but I think the MPC is on hold for the foreseeable future.

11 forecasters in a Wall Street Journal survey rate the chances of a US recession in the next 12 months at 50% or higher. Since economists almost never predict recessions we can confidently assert that either a contraction has already started or – more likely – will be avoided.

US GDP grew at a 4.0% annualised rate in the second quarter and is likely to register further expansion in the third. Despite housing gloom consumers continue to spend: real outlays rose in July and available evidence suggests a further gain in August. Payrolls growth has slowed sharply in recent months but this partly reflects a surprise cut in government jobs, which is likely to prove temporary. Daily information on withheld tax receipts does not suggest the labour market has fallen off a cliff.

Money market dislocation will hit growth in the fourth quarter but the impact is uncertain and will depend on how long current conditions persist. A useful summary measure of system dysfunction is the spread between the discount rates on non-financial commercial paper and Treasury bills. On three month paper the gap is currently 110 basis points – far above the normal 25-50 b.p. and a level historically consistent with recessions. I will be concerned if this gap fails to narrow significantly by mid October.

The chart shows two versions of our US recession probability indicator, designed to look out six months. The original version suggests recession risk remains low but arguably fails to capture current market dislocation. A new version was therefore estimated including the commercial paper / Treasury bill spread. Assume conservatively that the spread averages 100 b.p. over the remainder of the year. Even on this basis the model suggests the odds are (just) against recession.

Our MPC-ometer forecasts an 8-1 vote for unchanged rates in September with one lonesome dove seeking a quarter-point cut. No great surprise there. The bigger issue is whether the next move in rates will be up or down. Assuming GDP growth and inflation follow the MPC’s forecasts and other inputs remain at current levels, the MPC-ometer assigns a 20% probability to another rate rise before year-end, with a 10% chance of a cut. I think rates are on hold for the foreseeable future but money growth needs to moderate to convince me that the next move will be down. Historically rate peaks have usually been signalled by a slowdown in narrow money growth as measured by “non-interest-bearing M1” – currency in circulation and conventional current accounts. M1 has picked up recently, its annual increase jumping from 2% in May to 10% in July. Broad aggregates are even stronger: the widest M3 measure grew by an annual 16% in July – the highest since 1996. Tighter credit market conditions should contribute to a slowdown but rates of monetary expansion need to fall significantly to be compatible with the inflation target over the medium term.