The significance accorded by media commentators to OECD and IMF forecasts remains a mystery. Both were later even than the consensus of economists to recognise last year's developing recession. Neither predicted the emerging strength of the current recovery, reflected in a V-shaped rebound in industrial output in emerging economies and this week's upbeat G7 manufacturing surveys.

Both are political bodies and thereby constrained from issuing forecasts implying criticism of member governments' policies. The IMF's warnings of financial and economic doom since late 2008 have not been unrelated to its demands for additional funding.

Both organisations have been unaccountably, and so far wrongly, negative on the UK's relative economic performance, predicting late last year that Britain would suffer the largest annual decline in GDP among the major economies in 2009. Even based on the OECD's latest forecast that UK GDP will continue to contract during the second half while the US and Euroland recover, the calendar 2009 fall of 4.7% will be smaller than in Germany (4.8%), Italy (5.2%) and Japan (5.6%).

The projected further UK decline, however, is implausible. June data on services and industrial output already suggest a marginal GDP rise in the third quarter. Recent purchasing managers' surveys are consistent with expansion and stronger than their Eurozone counterparts. Broad money trends are also more favourable in the UK: the 4.9% annualised rise in adjusted M4 between January and July compares with growth of just 0.3% in Eurozone M3.

The OECD bases its UK pessimism partly on the larger role of the financial sector in the economy. Yet the last CBI financial services survey signals that the big recovery in markets since the spring is already contributing to a revival in business volumes, suggesting a positive GDP impact going forward – see chart.

The GDP rises in Germany and France in the second quarter partly reflected temporary "cash for clunkers" effects and pay-back for earlier extreme German weakness. Germany may continue to outperform other EMU members as global trade revives but Euroland as a whole is likely to lag the UK in the coming recovery.

The August minutes contained yet another surprise for MPC-watchers, with three members voting to expand asset purchases by £75 billion rather than the £50 billion favoured by the majority. The difference, however, should not be exaggerated: the Committee agreed that the new purchases should be spread over three months and the size of the programme is unlikely to be revisited before the November meeting, when the MPC will update its quarterly forecasts. If the economy evolves in line with the projections in the August Inflation Report, there will be no justification for continuing gilt-buying and by early 2010 the Committee will be under pressure to start withdrawing monetary stimulus.

A useful summary measure of the implications of the Inflation Report for future policy direction is the MPC’s mean forecast for inflation in two years’ time based on unchanged policies. This forecast fell to a record low of 0.38% in February, signalling that the Committee judged significant further easing to be necessary – the gilt purchase programme was announced the following month, along with a half-point cut in Bank rate. In the May Report, the two-year-ahead forecast was raised to 1.71% but the shortfall from the 2% target indicated that the MPC retained an easing bias. This residual bias partly explains the decision to expand asset purchases further in August.

The August Report, however, suggests that the £50 billion expansion was larger than strictly necessary because the two-year-ahead forecast is now above the target, at 2.17%. This is the first positive deviation since last August and the largest since August 2007 – the MPC last raised Bank rate in July 2007. The Committee’s decision to adopt a looser policy than warranted by its projections appears to reflect a judgement that the economic costs of inflation undershooting the target would exceed those of an overshoot. It has, in effect, taken out temporary insurance against worse-than-expected outcomes.

The emphasis, however, is on “temporary”, since such an approach risks damaging inflation-fighting credibility. Moreover, if the economy performs in line with the MPC’s mean expectations, the deviation between the current policy stance and one calibrated to achieve 2% inflation will widen. The August Report shows mean inflation climbing by 0.2 percentage points between the third quarter of 2011 and the first quarter of 2012 in the forecast based on market-implied interest rates; the increase would be greater if rates are unchanged. So the two-year-ahead projection based on unchanged policies could rise from 2.17% currently to about 2.5% by early next year. A 0.5 percentage point excess over the target would be at the top of the historical range.

Taken at face value, therefore, the August forecasts seem to lay the foundations for a withdrawal of monetary stimulus in early 2010. Of course, with economic recovery at an early stage and unemployment possibly still rising, any such action would be controversial. Moreover, some MPC members may argue for a delay to monitor the impact of the January VAT rise, although an assessment has already been built into the projections. The imminent general election may also affect the Committee's willingness to follow the logic of its forecasts – political sensitivities may be heightened by the Conservative proposal to transfer responsibility for financial regulation from the Financial Services Authority to the Bank of England.

While the likelihood of policy tightening in early 2010 can be debated, the August Report appears to rule out further loosening unless growth and / or inflation fall significantly short of the MPC’s expectations. This seems unlikely. The GDP forecast based on unchanged policies shows a mean rise of only 1.1% in the year to the second quarter of 2010 but purchasing managers’ indices have recovered close to long-term averages, consistent with annualised growth of more than 2%, while an end to destocking alone will give an arithmetical boost of 1.4 percentage points.

The MPC has revised up its short-term inflation projections significantly since the May Report, now expecting an annual CPI gain of 1.3% in the third and fourth quarters, but this is possibly still too low in light of July’s higher-than-expected outcome of 1.8%. While food price trends are favourable, core inflation may remain disappointingly sticky, reflecting lagged currency effects and – perhaps – a smaller "output gap" and / or lower sensitivity to economic slack than widely assumed. Also worthy of note is a likely strong rebound in retail price inflation from late 2009, which may boost measures of household inflation expectations monitored by the MPC. (See previous post for more discussion of inflation prospects.)

An eventual withdrawal of monetary stimulus is likely to take the form of a rise in Bank rate rather than a reversal of quantitative easing. The Bank of England could drain banks' excess cash reserves, by selling bills or reducing repo lending, but such action would probably have little economic impact. A run-down of the Bank's gilt portfolio is unlikely to be possible next year given forecasts that fiscal funding needs will remain gargantuan – unless officials are prepared to risk triggering a major rise in yields. With "quantitative tightening" off the agenda, and given the historically low starting level, rises in Bank rate, when they begin, could be larger than in the initial stages of prior cycles.

Purchasing managers' new orders indices support hopes of a strong recovery in G7 industrial activity during the second half – see first chart. This pick-up, however, partly reflects temporary factors such as slower destocking and "cash for clunkers" schemes. Sustained growth will require companies to move out of retrenchment mode and in particular to resume hiring, thereby providing income support for increased consumer spending

Other components of the latest surveys indicate that companies are reacting cautiously to unexpected strength in incoming demand. For example, while the US Institute for Supply Management (ISM) new orders index reached a five-year high last month, employment, inventories and import indices remain below their historical average readings – second chart.

One scenario is that orders strength will fade rapidly, validating firms' scepticism. This is unlikely: stocks cycle upswings typically last 12-18 months and the current boost should be unusually large given record destocking in late 2008 and early 2009.

Alternatively, firms may wait for higher orders to be sustained for a couple more months before shifting into expansionary mode. This is plausible and would be consistent with behaviour in previous cycles. However, companies may be more risk-averse given recent traumas while restricted credit availability may limit their ability to ramp up production and hiring.

This raises the possibility of a third scenario, in which order flows remain strong but the supply-side response is less dynamic than in prior upswings. As well as a less steep recovery trajectory, this would imply an earlier emergence of supply constraints and upward pressure on prices than suggested by consensus analysis based on highly-uncertain "output gap" estimates.

An indirect measure of US supply pressures is the ISM vendor deliveries index – higher values indicate more firms reporting delivery delays. Interestingly, this rose sharply in August to its highest level since May 2006. Historically, large increases have often preceded rises in US official interest rates, although the index would need to climb significantly further to reach its level before the Fed last began to tighten in June 2004 – third chart.

Weak second-quarter monetary data contributed to the MPC's decision last month to embark on an additional £50 billion of gilt purchases. July statistics released today are more encouraging, supporting recovery hopes and reducing the chances of further QE expansion.

Key points:

1. The MPC's favoured broad money measure – M4 excluding money holdings of "intermediate other financial corporations" – rose by a respectable 0.6% in July while first-half growth has been revised up from 3.5% annualised to 4.4%. Broad money increased by 4.9% annualised in the first seven months of 2009.

2. The Bank of England estimates that broad money rose by an annual 3.9% in July, which compares with a 1.2% gain in the retail prices index excluding mortgage interest costs. Implied real growth of an annual 2.6% contrasts with a contraction of 1.1% in Sepember last year and is higher than at the start of the economic recovery in the early 1990s.

3. M4 holdings of private non-financial corporations rose by 0.2% in the year to July – the first annual increase since March 2008. M4 lending to such corporations continued to contract in July, falling 2.9% from a year earlier. However, this partly reflects companies choosing to use the proceeds of recent capital issues to repay bank borrowing.

4. Historically, business spending has been positively correlated with the corporate "liquidity ratio" – M4 holdings divided by lending. Reflecting recent debt repayment, the ratio has recovered to its highest level since March last year. A wider definition including foreign currency deposits and loans has risen by more – see first chart.

5. Credit demand needs to revive to support M4 expansion when QE ends. Excluding remortgaging, mortgage approvals rose by 6% in July to stand 37% higher than a year earlier, suggesting a pick-up in mortgage lending later in 2009 – second chart.