The UK's inflation performance appears to compare unfavourably with the US – "official" consumer price indices rose by 3.7% and 2.2% respectively in the year to April. The gap, however, largely disappears if US inflation is recalculated using the European Union's "harmonized index of consumer prices" (HICP) methodology. US HICP inflation was an annual 3.5% in April.

The US figure comes from a table of international HICP inflation rates published each month by the US Bureau of Labor Statistics. The UK and US April annual rates of 3.7% and 3.5% compare with 1.5% in the Eurozone and -1.4% in Japan. Similar UK and US inflation experience could reflect identical monetary policy strategies, involving large-scale "quantitative easing" and currency depreciation.

A key difference between the official US consumer price index (CPI) and the HICP is that the latter excludes owner-occupied housing costs, of which the most important component is "owners' equivalent rent" (OER) – a notional payment by homeowners to themselves for accommodation. OER has a 25% weight in the CPI basket and is estimated – based on market rents – to have fallen over the last year, exerting a major drag on official inflation measures.

It is debatable whether OER, involving no cash transaction, should be a component of the CPI basket. An implication of its inclusion is that homeowners' financial position has improved as a result of the recent decline in rents, even though this fall is a lagged consequence of a housing market slump that has slashed the value of their properties – by 32% from peak to trough according to the Case-Shiller house price index.

US "core" inflation (i.e. excluding food and energy) would also be significantly higher using the HICP methodology. A back-of-the-envelope calculation based on the CPI / HICP inflation gap adjusting for the larger weight of OER (32%) in the core basket suggests an April annual rate of about 2% versus an official 0.9%.

The lower official measure, heavily reliant on OER weakness, is helping the Federal Reserve to justify sustaining its super-loose monetary stance and encouraging claims that the US stands on the brink of deflation. The Fed would face a tougher task if required, like the Bank of England, to evaluate inflation performance using the HICP.

The world earnings revisions ratio – the number of analyst upgrades to company earnings forecasts minus downgrades divided by the total number of estimates – turned negative in June for the first time since July last year. The ratio correlates closely with business surveys, suggesting that these will weaken over the summer – see first chart.

It is normal for output momentum to moderate and surveys to soften about a year into an economic recovery as the initial boost from the stocks cycle fades – second chart. The slowdown phase, on average, lasts about six months and is followed by renewed acceleration, although this conceals significant variation.

The emerging slowdown was foreshadowed by weaker real narrow money growth – third chart. Real M1 is still expanding and the rate of increase appears to have stabilised recently, consistent with the view that economic softening represents a "pause to refresh" rather than the start of a "double dip". Further M1 weakness, however, would demand a rethink. 

It would be understandable if some Monetary Policy Committee (MPC) members felt wary about the Osborne-King deal, under which the Chancellor believes he has bought off interest rate rises by acceding to the Governor's demands for accelerated fiscal tightening while transferring supervisory powers to the Bank, including new "macro-prudential" tools to be wielded by a rival Financial Policy Committee. They might, in addition, be uncomfortable with Mr. King's unilateral reinterpretation of the MPC's target as "2% inflation at some point in the future excluding the impact of temporary factors and ignoring any price-level overshoot in the interim".

Such frustrations, perhaps, contributed to external MPC member Andrew Sentance's surprise decision to vote for an immediate quarter-point rate hike this month, despite financial fragility in the Eurozone and the imminent emergency Budget. His view – that accelerating real and nominal growth, persistently high inflation outcomes and doubts about the dampening impact of spare capacity warrant some withdrawal of current exceptional stimulus – is shared, however, by a significant minority of economists, including the four members of the Sunday Times Shadow MPC who also favour immediate tightening (see David Smith's blog for the minutes).

The "MPC-ometer" model – which attempts to forecast the monthly vote based on the latest economic and financial indicators, with indicator weights derived from regression analysis of historical decisions – similarly predicted a three-member minority to hike this month. Yet the minutes suggest little support for Dr. Sentance's argument, with an opposing minority even claiming that downside inflation risks have increased. The Governor, it seems, exerts an iron grip. A decision by the Chancellor to fill the external MPC vacancy with another neo-Keynesian sympathizer will seal the Osborne-King deal and confirm that the inflation-targeting regime has changed.

The story so far:

US and global equities have been following fluctuations in the US monetary base (i.e. currency plus bank reserves) over the last 18 months – see first chart. The most recent low in the base occurred in early May; the Dow Industrials index troughed five weeks later. The subsequent recovery in the base, however, stalled a month ago, suggesting that the rally in equities may be in the process of rolling over.

More positively, the Eurozone monetary base on an expanded definition including one-week term deposits – likely to be regarded by banks as a close substitute for reserves – has continued to rise strongly in recent weeks. The environment is reminiscent of June / July last year: the US monetary base moved sideways but the Dow rallied following a surge in the Eurozone base.

In contrast to then, however, the macroliquidity fundamentals are less favourable, with G7 real M1 growing more slowly than industrial output – see prior post. The stalling of the US monetary base in summer 2009, moreover, was clearly temporary given the Federal Reserve’s quantitative easing plans.

These various cross-currents may mean that equities continue to fluctuate in a trading range that frustrates both bulls and bears, an outcome also suggested by the “six-bear comparison” discussed in previous posts – second chart.

A more positive outlook would be signalled by Fed action to boost US monetary base. The most likely form would be a suspension of the “supplementary financing program” under which the Fed has borrowed $200 billion from the Treasury – repayment of this sum would inject an equivalent amount into bank reserves.

The Chancellor delivered a decisive Budget that should greatly reduce worries about fiscal sustainability. The composition of the measures announced was also welcome, with an emphasis on current spending reductions and indirect tax rises that should be less damaging to economic performance.

However, the new fiscal mandate – to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period – is unconvincing. Estimates of the cyclically-adjusted balance are highly uncertain and it is doubtful that the rule, even if monitored by the new Office for Budget Responsibility (OBR), would have constrained the fiscal policy of the last Government.

Other points:

• The additional £40 billion of savings by 2014-15 announced today builds on £73 billion implied by the previous Government's plans, bringing the total to £113 billion – equivalent to 6.3% of projected GDP in that year. Spending cuts account for £83 billion, or 74%, of the overall adjustment.

• While the Chancellor focused his axe on current spending, capital investment continues to bear an excessive burden of the overall adjustment, mainly reflecting the previous Government's plans. Investment is projected to fall by 42% in real terms between 2009-10 and 2014-15, accounting for two-thirds of a 7% fall in total managed expenditure excluding interest payments.

• The cyclically-adjusted current balance is forecast to be in surplus by 0.8% of GDP at the end of the five-year forecast period in 2015-16, implying that the Chancellor has built in about £15 billion of leeway that he will be able to "give away" before the next election. Put differently, he could have avoided raising the standard VAT rate to 20%, raising £13 billion by 2014-15, and still achieved the fiscal mandate.

• The OBR's assumptions about the longer-term impact of fiscal tightening on growth assist the Chancellor but will displease Keynesian economists. The OBR forecasts that real GDP will be 0.3% lower in 2014-15 than in its pre-Budget forecast despite a 2.0% of GDP reduction in cyclically-adjusted borrowing, suggesting a fiscal multiplier of only 0.15. (The OBR warns that its earlier forecast may have been biased up, in which case the true multiplier would be even lower.)

• The OBR's forecast of public sector net borrowing of £149 billion in 2010-11 looks overly cautious in light of recent encouraging monthly numbers, suggesting an outturn of below £130 billion – further grounds for questioning whether a VAT rise was necessary at this stage.