None of the three main parties has been honest with the electorate about the scale of fiscal retrenchment needed to stabilise the public finances but the Conservatives have been most vocal about the dangers of failing to make an early start on reducing the deficit. Their inability to achieve a clear mandate indicates that the new government, whatever its composition, will face strong public resistance to the required actions.

The stability of the pound and gilt yields for most of the campaign had led some to suggest that markets were comfortable with the prospect of an inconclusive result. This stability, however, partly reflected a “safe-haven” influx of capital fleeing peripheral Eurozone economies. The risks that could be downplayed while the polls fluctuated have now crystallised. The initial negative market reaction is more likely to extend rather than be reversed on further reflection.

The “best-case” scenario for markets is a minority Conservative government that presses ahead with an early emergency budget setting out a credible deficit-reduction programme. The need, however, to appease collaborators suggests that this would be less ambitious than required. The alternative scenario of a Lab-Lib coalition, in theory, would delay any new fiscal announcements until an autumn Pre-Budget Report. In either case, the credibility of medium-term proposals would be low given the likelihood of another election within a year or so.

The notion that delaying fiscal tightening will boost near-term growth prospects is a fallacy. Policy uncertainty will cause businesses to delay plans to expand investment and hiring while consumer caution will similarly increase. A likely rise in the “risk premium” in UK market interest rates will act as a further drag on the recovery. Inflation expectations, meanwhile, may firm, with markets suspicious that the Bank of England will restart gilt-buying in the event of deficit-financing difficulties, even if this conflicts with its inflation-targeting remit.

A post in late March argued that the global monetary backdrop remained consistent with a solid economic recovery but no longer supported further market gains. The escalation of the Eurozone sovereign debt crisis and the recent set-back in equities may be symptoms of deficient liquidity.

One reason for caution was a fall in G7 annual real M1 expansion below industrial output growth – equities have tended to underperform cash following such cross-overs. The US Federal Reserve, meanwhile, has engaged in "stealth" tightening since February, using Treasury bill sales to drain $174 billion from banks' reserve accounts. The Fed may partly reverse this withdrawal if markets continue to deteriorate.

The latest monetary statistics confirm the earlier assessment. The charts show six-month growth rates of G7 and E7 output and real M1. G7 real M1 expansion appears to be stabilising following a slowdown while E7 real M1 continues to boom. Combined growth looks consistent with an ongoing economic recovery.

Six-month G7 real M1 expansion, however, remains below industrial growth, suggesting insufficient liquidity to push markets higher. This relationship bears monitoring – output momentum is moderating and central bank responses to current turbulence could cause real M1 to reaccelerate. A positive cross-over of annual growth rates, however, is unlikely until late summer at the earliest.

March monetary statistics look consistent with an ongoing economic recovery:

• M4 excluding money holdings of non-bank financial intermediaries rose by 1.1% from February and by 5.9% annualised over the last three months. This confounds the Cassandras who claimed that broad money would contract if the Bank stopped buying gilts.

• M4 ex. is still only 1.2% higher than a year ago but this is unlikely to signal insufficient liquidity to support economic growth because the demand to hold bank deposits has fallen in response to negative post-tax real deposit rates. Consistent with a portfolio shift away from money, retail sales of unit trusts and OEICs totalled a record £27.2 billion in the year to March – equivalent to 2.7% of household M4 and up from £7.9 billion in the previous 12 months.

• Importantly, available liquidity continues to flow to the corporate sector, supporting hopes of a post-election pick-up in investment and hiring. M4 holdings of private non-financial corporations rose by 0.5% in March for an annual gain of 4.0%. With companies also adding to foreign-currency deposits while continuing to repay bank debt, the liquidity ratio is at its highest level since September 2007 – see chart.

• Narrow money M1 is still growing solidly – by 5.9% in the year to March.

• Mortgage approvals remain weak – 49,000 in March versus a peak of 57,000 last October – but housing market activity has probably been depressed by the election. A net 40% of banks reported expectations of stronger demand for mortgages for house purchase over the next three months in the April credit conditions survey.

Today's statistics also reveal that foreign investors were heavy buyers of gilts and Treasury bills in February and March, probably reflecting capital flight from Greece and other peripheral Eurozone economies. Net purchases were a record £27.6 billion for the two months – greater than the £23.8 billion inflow in all of 2009.