Recent posts have argued that the consensus is misreading the monetary data and underestimating the degree of stimulus to asset markets and the wider economy from the current policy stance. News this week supports the view that economic performance and prospects are improving significantly.

First, a monthly GDP estimate based on services and industrial output data rose by 0.1% in July after a 0.3% June gain, to stand 0.2% above its second-quarter average – see first chart. With business surveys suggesting a further recovery and upward revisions possible, GDP may have grown by as much as 0.5% in the current quarter (preliminary figures will be released on 23 October).

Secondly, the EU Commission measure of consumer confidence vaulted higher in September and is now only marginally below its long-term average. UK confidence has recovered much more strongly than in other major economies – second chart. In addition to becoming more optimistic about the economy and their own finances, households are signalling reduced concern about labour market weakness, suggesting that unemployment could peak earlier than many expect.

Thirdly, the number of upgrades to company earnings forecasts by equity analysts is exceeding downgrades by a widening margin, which is usually a sign of rising economic momentum. The "revisions ratio" (i.e. net upgrades divided by the total number of earnings estimates) correlates with business surveys and suggests further improvement in forthcoming purchasing managers' indices – third chart.

UK broad money growth remained sluggish in August but narrow money posted another strong gain, corporate liquidity continues to improve and mortgage lending is recovering. These developments suggest that the broad money numbers understate monetary support for the economy, i.e. the velocity of circulation may now be rising.

1. M4 excluding "intermediate other financial corporations" rose by 0.2% in August, down from 0.4% in July, with the decline probably due to smaller Bank of England gilt purchases (£12 billion versus £23 billion). Incorporating downward revisions to earlier numbers, broad money grew by 4.0% annualised in the first eight months of the year.

2. By contrast, "non-interest-bearing M1" – comprising cash and interest-free current accounts – rose by 1.8% in August, giving a year-to-date annualised gain of 46%. As discussed in recent posts, narrow money strength relative to broad money is often an indicator of a pick-up in velocity. (Note: non-interest-bearing M1 includes only current accounts with no advertised interest rate, i.e. it is not distorted by the rate on some accounts being cut to zero.)

3. Private non-financial corporations' cash and deposits rose last month, with a small fall in their M4 holdings offset by a rise in foreign currency assets. With bank borrowing little changed, a foreign-currency-inclusive measure of the liquidity ratio rose further to its highest level since October 2007 – see first chart.

4. M4 lending excluding intermediate OFCs slumped by 0.5% last month but this was entirely due to financial corporations, whose borrowings are often volatile. Lending to households and private non-financial corporations rose by 0.1%.

5. Net mortgage lending recovered to £1.0 billion in August while the value of mortgage approvals for house purchase reached its highest level since April 2008. The number of approvals, however, was marginally lower than in July, indicating that the lending pick-up is weighted towards higher-value homes – second chart. Net lending remains on course to recover to about £2 billion over coming months – see earlier post.

While the primary cause appears to be relatively loose UK monetary conditions, sterling's recent slide was given an additional fillip last week by comments by Bank of England Governor Mervyn King again welcoming a weaker pound. This extends a previously-documented pattern of the Governor's public utterances coinciding with currency depreciation.

Since August 2008, Mr King has presented at five Inflation Report press conferences and given four set-piece speeches. A strategy of shorting the effective index at the close before each appearance and covering the position 24 hours later would have been profitable on all nine occasions. Assuming no gearing, the strategy would have returned a cumulative 11.9% over nine trading days – an annualised gain of more than 2000%.

The benefits of sterling depreciation were questioned in a post last December, which suggested that the inflation cost would be greater than assumed by the MPC and the consensus; this appears to have been borne out by disappointing CPI outturns this year. Official remarks are unlikely to have any lasting effect on currency movements but it is nonetheless surprising that Mr King continues to sing the praises of a slumping pound.

Further evidence of a fall in the demand to hold money is provided by Investment Management Association figures showing £2.2 billion of net retail sales of unit trusts and OEICs in August, a record for the month – see chart. Sales remain on course to reach £24 billion in 2009, above the 2000 peak of £18 billion and up from just £4 billion last year.

As previously explained, if this year's increase is a reflection of reduced money demand, broad money numbers will understate the growth in cash available to support a recovery in the economy and markets by about £20 billion, equivalent to 1.3% of M4 excluding "intermediate other financial corporations".

Sales of bond and equity funds were similar in August, at £742 million and £696 million respectively, while property inflows continued their recent revival, reaching £129 million – the highest since June 2007.

Sterling's effective rate index reached a nine-month high on 5 August, the day before the Bank of England's announcement of a £50 billion expansion of its quantitative easing programme. It had fallen by 6.9% by last night's close, with a further move lower this morning. The timing is unlikely to be coincidental. The Bank's gilt-buying may be creating excess liquidity in the economy, helping to explain surging equity and prime property prices as well as the fall in the pound.

The suggestion that monetary conditions are over-expansionary may appear strange given recent sluggish growth in the Bank's favoured broad money measure – 5% annualised between January and July. However, the velocity of circulation of money is probably rising in response to record low interest rates and reviving risk appetite so the current rate of expansion may be more than sufficient to support an economic recovery, implying an excess available to push up asset values, including the sterling price of foreign currencies.

A recovery in velocity is suggested by a recent shift of funds out of savings accounts into cash and accounts used for transaction purposes: "non-interest-bearing M1" – comprising cash and interest-free current accounts – rose by 46% annualised between January and July. Strong retail buying of unit trusts and OEICs is also consistent with a reduced demand to hold money – see earlier post.

Though the figures relate to the second quarter, today's National Statistics release on institutional investment flows provides evidence that some of the liquidity created by the Bank's gilt-buying is flowing overseas. Insurance companies, pension funds and trusts bought £13 billion of foreign shares and bonds last quarter – the highest since the third quarter of 2007.

With the economy recovering and inflation continuing to overshoot the Bank's forecasts by an embarrassingly large margin, the case for a further extension of QE was already looking weak. Sterling's slump adds to the reasons for caution and – if sustained – could lead markets to bring forward expectations for monetary tightening.

G7 broad money has slowed significantly this year, with an estimated rise of only 2% annualised in the six months to August – see first chart. A theme of recent posts is that this weakness is not of undue concern because the velocity of circulation is likely to be rebounding after a plunge in 2008 and early 2009. Expressed differently, the demand to hold cash has fallen in response to record low interest rates and reviving markets so weak monetary growth does not signal insufficient liquidity to support an economic recovery.

Prior posts have also noted that a rise in broad money velocity is likely to be associated with a shift of funds out of savings accounts into cash and accounts used for transactions, implying a pick-up in narrow money relative to broad money. Continued solid growth in G7 M1 – an estimated 7% annualised in the six months to August – is therefore reassuring.

The relationship between velocity and the ratio of narrow to broad money is demonstrated for the US in the second chart. Velocity is normally calculated using nominal GDP and money supply data for the same period but this ignores lags in the transmission mechanism; the measure in the chart divides GDP by M2 six months earlier. For narrow money, "non-interest-bearing M1" is used, comprising currency, traveller's cheques and "demand deposits" – interest-free accounts with a cheque facility.

There is a clear pattern of changes in the narrow to broad money ratio leading swings in velocity. The ratio is currently growing at an annual rate of 10%, which is the fastest since 1992-93, when M2 velocity rose by 4-5% per annum. A similar increase over the coming year would imply a strong rebound in nominal GDP – even if M2 shows little growth.