Today's solid retail sales numbers (+0.4% in October with upward revisions to prior months) were foreshadowed by a pick-up in "retail M4" – notes and coin in circulation plus bank and building society retail deposits. Annual growth in this measure rose further to 6.1% last month, the highest since June last year – see first chart.

Meanwhile, mortgage approvals for house purchase by large UK banks continued to recover last month – second chart. The current rate of approvals is consistent with industry-wide net mortgage lending rising to about £3 billion per month in early 2010 from an average of only £600 million in the second and third quarters.

By contrast, public borrowing figures for October were disappointing, with the deficit after seasonal adjustment reaching another new record – third chart. Nevertheless, there is still a chance that the full-year shortfall will be within the £175 billion Budget forecast – this implies a seasonally-adjusted deficit of £17 billion per month over the remainder of 2009-10 versus an average of £13.5 billion in the last three months.

A big decline in pay growth since early 2008 is often cited as a reason for expecting lower inflation. This fall, however, largely reflects cuts in bonuses and working time rather than a slowdown in hourly wages.

The official average earnings index measures pay per worker and is separable into regular and bonus elements. The chart shows annual growth in total and regular earnings together with an adjusted regular pay measure taking into account changes in average weekly hours.

Headline earnings growth has fallen from an annual 4.0% in the first quarter of 2008 to 1.2% in the third quarter of this year with the bulk of the decline due to a slowdown in regular pay expansion from 3.8% to 1.8%. This latter reduction, in turn, mainly reflects a cut in average working time from 32.2 to 31.5 hours per week since last year's first quarter.

Regular hourly pay growth, by contrast, has slowed only marginally, from an annual 3.5% in the first quarter of 2008 to 3.4% by this year's third quarter.

Firms may base pricing decisions on trends in hourly pay rather than earnings per worker. This is because reductions in bonuses and working hours are usually associated with lower output so do not result in a fall in unit labour costs.

The limited response of hourly pay growth to labour market weakness may partly explain recent core inflation resilience, although this mainly reflects the impact of sterling depreciation and pass-through of global commodity price rises.

The rise in consumer price inflation from an annual 1.1% in September to 1.5% in October marks the start of a trend that is likely to carry the headline rate above 3% in January, necessitating a sixth explanatory letter from Bank of England Governor Mervyn King to the Chancellor. Inflation should subside over the remainder of 2010 but is unlikely to fall below the 2% target, as forecast by the Bank of England in the November Inflation Report.

The headline rate continues to be flattered by last December's VAT cut and lower energy prices than a year ago. The Office for National Statistics has estimated an effect on the headline rate from VAT and duty changes of 0.5 percentage points, suggesting that inflation would be 2.0% in October in the absence of the reduction. On the same basis, "core" inflation – excluding energy, food, alcohol and tobacco – might stand at 2.7% rather than the reported 1.8%.

Petrol prices accounted for much of the rise in headline inflation between September and October but there were also significant upward contributions from cars, flights, food, DVDs, computer games and landline telephones.

Inflation has overshot the Bank's forecasts by an embarrassingly large margin this year. The central projection in the May Inflation Report showed the CPI headline rate falling to just 0.4% in the fourth quarter. Further increases in November and December are likely to result in an outturn of 2.0% or higher. The Bank's forecasts have proved too low because it overestimated the impact of economic slack on core price trends while underestimating upward pressure from exchange rate depreciation and global commodity prices. There is little sign that it has learnt from its mistake, with the November Report continuing to place heavy emphasis on "output gapology" while playing down external price risks.

The RPI headline rate moved up from -1.4% to -0.8% between September and October and will rise much more sharply than CPI inflation over the next six months, reflecting house price and mortgage rate base effects. Even assuming house price stabilisation, RPI inflation is likely to reach about 4% by next spring, with higher figures obviously implied by any increase in official interest rates. Governor King last week stated that the Bank intended to "look through the short-term rise in inflation" but there is a risk that sharply higher headline rates will destabilise inflationary expectations in the absence of any policy response.

The charts update previously-presented profiles for CPI and RPI inflation taking into account October data and revised assumptions about energy and food prices. In particular, the 5% cut in household energy tariffs incorporated in the earlier forecast has been removed, in line with Bank's assumption in the latest Inflation Report.

The relationship between the US monetary base – currency in circulation plus bank reserves at the Fed – and the performance of stock markets, commodities and other "risky" assets remains intact. The new high reached by the Dow Industrials last week followed a 9% surge in the base between the end of September and early November – see first chart.

The base contracted in the week to last Wednesday but this is unlikely to mark a change in trend. The Fed is scheduled to buy $500 billion of mortgage-backed and other agency securities by the end of the first quarter. This cash injection will be offset by a further decline in various forms of "emergency" lending, including term auction credit, discount window loans, commercial paper holdings and liquidity swaps with other central banks. These four items, however, currently sum to $172 billion – even in the unlikely event of the total falling to zero, the effect on reserves would be swamped by securities purchases.

The Fed could, in theory, sterilise the impact of its buying on the monetary base by conducting reverse repurchase agreements (repos), involving banks lending excess cash back to the central bank in return for securities. (The Bank of England has effectively sterilised the base effects of its asset purchases since August by cutting its short-term lending to the banking system.) Such an initiative, however, is unlikely before early 2010 and should be signalled in advance to reduce the risk of a large negative market reaction.

Expectations that US liquidity supply will remain ample at least until year-end have been reflected in further capital outflows from the US to Asia in particular. Currency board arrangements in Hong Kong result in a direct impact on the monetary base, which has climbed by 16% since the end of September, providing strong support for the local stock market and Hong-Kong-listed Chinese "H" shares – second chart.