The transfer of responsibilities to the Office for Budget Responsibility (OBR) is unlikely to result in an improvement in fiscal forecasting, which is notoriously difficult.

The OBR this week projected a fall in public sector net borrowing excluding the temporary effects of financial interventions (PSNB ex) from £156.1 billion in 2009-10 to £155 billion in 2010-11. Recent trends suggest a significantly smaller deficit. May public finances numbers released today revised down the 2009-10 outturn to £154.7 billion. More importantly, monthly borrowing including intervention effects, after attempting to adjust for seasonal factors, has been running at about £10 billion recently, or £120 billion annualised – see chart. Assuming no further change, this is consistent with the PSNB ex measure falling to £126 billion in 2010-11, based on the Treasury's March forecast that intervention effects would reduce headline borrowing by £6 billion this year. (PSNB ex figures are currently available only quarterly but will be published on a monthly basis from July.)

The OBR's caution in extrapolating recent better trends is helpful for the Chancellor as he seeks to justify further significant tightening in next week's Budget.

"Monetary stability" should be understood to involve a stable price level or very low rate of inflation over the long run coupled with avoidance of credit boom / bust cycles, which inflict major damage on economic performance. The two objectives are intertwined: historically, credit cycles have invariably been associated with significant and sustained price disturbances.

The Chancellor's plan, therefore, to separate responsibilities for inflation and credit control between two policy-making bodies is questionable. It would have been preferable to assign new "macroprudential" policy tools to the Monetary Policy Commitee (MPC) while expanding its remit to include leaning against major swings in money and credit expansion.

The interest rates faced by borrowers and savers play a key role in the transmission of policy changes to financial market conditions and inflation. One way of thinking about the new arrangements is that the MPC will set the risk-free rate while the Financial Policy Committee (FPC) will influence spreads by varying capital and liquidity requirements. The MPC's judgement, however, about the level of borrowing / saving rates needed to meet the inflation target may differ from the FPC's assessment based on its stability goals.

The FPC, presumably, would have leant against credit expansion during the 2005-07 boom, resulting in higher borrowing spreads and slower economic growth. Based on the MPC's forecasts at the time, however, this would have pushed prospective inflation below target, requiring the Committee to set a lower level of Bank rate, thereby undermining the FPC's attempt at credit restraint. Would the FPC have responded by requiring a further increase in capital / liquidity buffers?

The preferred alternative of adding credit stability to the MPC's responsibilities would have allowed such tensions to be resolved within a single policy-making body. The Chancellor, moreover, could have taken the opportunity to change the MPC's target from 2% inflation "at all times" to a 2% per annum average rise in the price level over the long run. This would allow larger short-term inflation fluctuations to accommodate temporary conflicts with the credit control objective while requiring the MPC to correct under- or overshoots, thereby providing a firmer anchor for long-run expectations than current arrangements (under which the Committee is able to tolerate a persistent deviation while claiming to be adhering to its remit).

The May Royal Institute of Chartered Surveyors (RICS) survey signals a rebound in housing market turnover following weakness related to the ending of the previous stamp duty holiday (since extended) and the election. The net percentage of agents expecting an increase in sales rose to an eleven-month high, probably presaging a pick-up in mortgage approvals – see first chart.

Despite a recent increase in sales instructions, stock levels are the lowest since November. The new buyer enquiries and prices balances remain positive, the latter at levels historically consistent with solid gains – second chart.

At least until official interest rates rise significantly, real house prices may continue to follow the pattern of the early 1980s recovery, implying increases of 4% and 7% (Nationwide measure) respectively in the years to the fourth quarters of 2010 and 2011 – see third chart and previous post for more discussion. Assuming, conservatively, 3% retail price inflation, this would entail nominal growth of 7% and 10%, resulting in prices regaining their 2007 peak by late 2011.

Such a scenario could be upset by harsher tax treatment of housing but the coalition will be brave to grasp this nettle – the consensus is that any rise in capital gains tax on second homes and buy-to-let investments in next week's Budget will be vitiated by generous taper relief.

The fall in consumer price inflation to an annual 3.4% in May from 3.7% in April was in line with a projected path presented graphically in a post a month ago and partly reflected favourable base effects, as well as a seasonally-unusual decline in unprocessed food prices.

The projection has been updated to take account of a recent easing of petrol prices and now shows the headline rate moving down to 2.9% by July, implying no further explanatory letter that month. It remains, however, well above the 2% target during the second half and rebounds in 2011, based on a firming of core price trends as the recovery develops and an assumed rise in the standard VAT rate to 20% in January – see first chart.

Tax changes aside, risks to this forecast are weighted to the upside since it assumes a significant near-term slowdown in core inflation that is at odds with rising price expectations in business and consumer surveys – second chart.

Geek's note: the CPI at constant tax rates (CPI-CT) rose by only 1.6% in the year to May but this should not be used as an estimate of the hypothetical rate of inflation in the absence of this year's VAT hike because the calculation assumes full pass-through of changes. Based, more realistically, on 50% pass-through, CPI inflation would currently stand at 2.5% if tax rates had been constant over the last 12 months (i.e. the mean of the headline rate of 3.4% and CPI-CT rate of 1.6%).

Global industrial output – as proxied by combined production in the G7 major countries and seven large emerging economies (the "E7") – rose by a further 0.6% in April to stand just 1.4% below the pre-recession peak reached in February 2008. With business surveys signalling further gains, output is likely to reach a new high by late summer – see first chart.

A composite leading index derived from OECD country indices (except for Taiwan, for which a national series was used) also continued to rise in April but the 0.4% monthly increase was the smallest since February 2009. The index appears to be converging with the long-run trend path of output, with this trend implying growth of 3.4% per annum – first chart.

The loss of momentum of the leading index is clearer in the second chart, showing six-month growth rates. Pessimistic commentators suggest that this slowdown will intensify and is an early warning of renewed output weakness in late 2010 and 2011 – the dreaded "double dip".

Global narrow money trends, however, have yet to support such a scenario. Real M1 led output and the leading index around the recession trough in early 2009 and again at the recent momentum peak – third chart. Six-month growth has slowed significantly but remains solid and may be stabilising, suggesting that output and the leading index will continue to rise, albeit at a much-reduced pace.

The best guess here remains that the current recovery will follow the pattern of the output revival after the mid 1970s first oil shock recession, implying a mid-cycle "pause to refresh" in late 2010 and 2011 followed by renewed acceleration from late next year – fourth chart. Further weakness in real M1, however, would demand a rethink. A 2011 global slowdown, moreover, could involve stagnant G7 output, allowing for much faster E7 trend growth.