The MPC-ometer predicts that Bank rate will be held at 0.5% at tomorrow’s Monetary Policy Committee meeting. A split decision is indicated, however, with one or more members – probably including arch-dove David Blanchflower – voting to lower the target for official rates to between zero and 0.25%, the currently-prevailing US level.

The MPC-ometer forecasts the outcome of each month’s MPC meeting based on the latest economic and financial indicators. The no-change prediction reflects slightly less grim news over the last month: business surveys indicate a slower decline in new orders, consumers are a bit less pessimistic, share prices have rallied and money market conditions have eased.

As well as cutting rates to 0.5%, the MPC last month announced plans to boost the money supply by buying £75 billion of gilts and other securities by early June. It is much too early to judge the success of this policy but the Bank of England had purchased £21 billion by last week, suggesting it is on course to reach the target.

The broad money supply M4, adjusted for distortions due to the financial crisis, needs to grow by 6-7% a year to support economic expansion but rose by just 3.8% during 2008, contributing to the slide into recession. The MPC should calibrate asset purchases to boost annual growth in adjusted M4 to 10% to compensate for last year’s shortfall and lay the foundations for an economic recovery.

The initial plans look sensible – £75 billion is the equivalent of 4.5% of the adjusted money supply – but the MPC will need to fine-tune its operations in the light of incoming monetary data. The Bank of England is making it more difficult for outside observers to make a judgement on this issue by refusing to publish its monthly estimates of the adjusted M4 money supply.

The Bank gave the following response to a freedom-of-information request for access to the data:

Thank you for your email dated 5 March in which you request access under the Freedom of Information Act 2000 ('FoI Act') to:

'...the adjusted M4 and M4L data prepared monthly within the Bank (ie the monthly versions of the series that have been published quarterly in chart form - with underlying data available in a spreadsheet - in recent Inflation Reports)'

Monthly data used to calculate these adjusted measures is provided confidentially to the Bank. Moreover, that information is based on a restricted sample and is not considered sufficiently robust for disclosure. Equally, publication could potentially compromise confidential sources.

But in any case, the data is held by the Bank for the purposes of its monetary policy functions and is not, therefore, subject to the requirements of the FoI Act. Parts I to V of the FoI Act (including the general right of access under section 1) do not apply to information which the Bank holds for the purposes of its functions with respect to monetary policy (see section 7(1) and the Bank of England entry in Schedule 1, Part VI FoI Act).

US companies included in the S&P 500 index recorded a large aggregate loss in the fourth quarter, reflecting financial write-downs, a fall in the value of inventories due to plunging commodity prices and other recession-related charges – see first chart.

By contrast, the national accounts measure of “economic” profits was still firmly in the black in the fourth quarter. This covers all companies, excludes valuation effects and other charges, and adjusts for under- or over-depreciation in reported accounts. It is a better guide to underlying profitability.

Fourth-quarter economic profits were down by 18% from their peak in the third quarter of 2006 but 94% above the trough reached in the last recession, in the third quarter of 2001. Companies have limited damage to profitability by acting fast to shed labour and slash other costs.

The second chart shows inflation-adjusted economic profits together with a log-linear trend. At the 2006 peak, profits were 41% above the trend-line – the largest deviation since 1966. The subsequent plunge has closed the gap and profits should move below trend in early 2009.

Market valuations already discount earnings gloom. As the third chart shows, a price / earnings ratio based on trend economic profits stood at 12.6 at the end of 2008 versus a long-run average of 13.8. The P / E, however, reached much lower levels in the 1970s and 1980s.

From a liquidity perspective, market falls since late 2007 were caused by a fear-induced rise in the precautionary demand for money coupled with a withdrawal of credit from leveraged investors, resulting in forced selling of assets. Contrary to fears, the global supply of money has continued to expand but not sufficiently to offset these negatives.

As the second quarter begins, money supply trends are improving, risk aversion and precautionary cash demand appear to be moderating and investor leverage is at its lowest level for several years. This suggests support for equity markets but any rally faces hurdles from ongoing poor earnings news, a likely rise in issuance and a possible rebound in commodity prices.

A key policy development last quarter was the $1.15 trillion expansion of the Fed’s securities purchase programme, which promises to give a major boost to US and global monetary growth. Including the unutilised portion of earlier plans, the Fed could buy $1.4 trillion of assets over the remainder of 2009, equivalent to 11% of US M2+ and about 5% of our G7 broad money measure.

The demand for money is unobservable but cash hoarding is likely to diminish as fears of financial collapse abate and the economic cycle approaches a trough. Consistent with this view, measures of risk aversion have moderated recently – see chart – while narrow monetary aggregates have been rising relative to broader measures, which often precedes a pick-up in velocity.

Meanwhile, investor deleveraging appears to be well-advanced. US margin debt is back at 2003 levels while hedge fund returns have recently shown little correlation with equities, suggesting minimal market exposure. Hedge funds suffered investor withdrawals of $260 billion between November and January but outflows slowed to $17 billion in February, according to Trim Tabs.

While the liquidity backdrop for equities is improving, several factors could delay a significant recovery in markets. First, corporate newsflow may remain negative – another large fall in global GDP in the first quarter suggests the potential for downside surprises in coming earnings reports, even relative to recently-lowered expectations.

Secondly, any rally is likely to call forth an avalanche of issuance as companies seek to reduce gearing against the backdrop of high corporate borrowing costs. Balance sheet adjustment also implies that cash take-over activity and share buy-backs will remain weak for the foreseeable future.

Thirdly, “excess” liquidity resulting from a fall in money demand relative to supply could flow into commodity markets, particularly given investor concerns that unprecedented monetary and fiscal stimulus will lead to higher inflation over the longer term. A renewed commodity price surge would damage prospects for a recovery in economic activity and earnings recovery later in 2009.