Recent rises in global food commodity prices may lift annual CPI food inflation to about 7% by late 2010, from 1.7% in June, implying a boost of half a percentage point to headline CPI inflation. If food costs continue to spike, CPI inflation could reach 4%. Such an increase would hit consumer spending and recovery prospects and could destabilise inflationary expectations. This could warrant postponing or cancelling the coming VAT hike.

The Food and Agriculture Organisation (FAO) food index – a monthly measure covering meat, dairy products, cereals, oils and fats, and sugar – rose by an annual 22% in sterling terms in August, the fastest rate of increase since September 2008. Food prices have increased further in September: the Commodity Research Bureau daily spot food index is currently 7% above its August average, again in sterling terms.

Consumer food prices have already started to respond to these cost rises. Annual CPI food inflation increased from 1.7% in June to 3.0% in July (August figures are released on Tuesday). The historical relationship with the FAO index suggests a further rise to about 7% by late 2010 – see chart.

Rising pressures are confirmed by today's producer price numbers, with annual input cost inflation in food and beverages manufacturing rising from 3.2% in July to 4.6% in August. The British Retail Consortium's (BRC) shop price survey, meanwhile, showed a rise in food inflation from 2.5% to 3.8% between July and August.

In its August Inflation Report, the Bank of England forecast headline CPI inflation of 3.2% in the fourth quarter (mean projection). The Bank may have assumed that food inflation would remain at about 2% – the June reading of 1.7% was the most up-to-date when the Report was prepared. If so, a rise to 7% would boost the Bank's fourth-quarter forecast by half a percentage point, to 3.7%, given food's 9.6% weight in the CPI basket.

If a further food commodity price spike pushed CPI food inflation up to an annual 10%, the headline CPI rate could reach 4%. (10% food inflation would be below the peak of 14.5% reached in August 2008.)

Such an increase would damage recovery prospects by squeezing real income and money supply expansion. It would also risk destabilising inflationary expectations, particularly if the MPC were thought likely to respond to renewed economic weakness by restarting asset purchases.

A preferable policy response would be to postpone or cancel the VAT rise, thereby cutting headline inflation in early 2011 by about one percentage point. This could be justified partly by recent better-than-expected public sector borrowing numbers, suggesting that the 2010-11 total will undershoot the OBR's £149 billion forecast by at least £10 billion – the VAT increase is estimated to raise £12 billion in 2011-12.

The stock of commercial and industrial (C&I) loans advanced by US commercial banks shrank by 18% in the year to July. The pace of decline, however, has slowed sharply, with August figures due on Friday likely to show a three-month change of close to zero – see first chart. (The chart uses a new Federal Reserve dataset that adjusts for series breaks.)

In the Fed's July survey of senior bank loan officers, the net percentages reporting stronger demand for C&I loans from larger and small firms rose to +2% and -4% respectively. An average of the two series has been a leading indicator of C&I lending and the current reading is consistent with a return to expansion – second chart.

C&I lending accounts for only 18% of US banks' total "loans and leases" but they usually move together, with total lending also declining more slowly recently – third chart. The Fed survey also reported notable improvements in loan officers' assessment of demand for mortgages and consumer credit. The officials, meanwhile, signalled looser lending standards for C&I loans and prime residential mortgages and increased willingness to advance consumer installment credit – fourth chart.

A return to credit expansion, if confirmed, would increase confidence in the sustainability of the recovery, in part because of its likely positive impact on monetary trends.

The six-month growth rate of G7 industrial output is falling sharply, as previously signalled by the OECD's composite leading indicators index and, much earlier, G7 real narrow money, M1 – see chart.

The six-month change in real M1, however, bottomed in January and had recovered to a nine-month high by July, suggesting that economic weakness should abate by the end of 2010.

In terms of six-month rates of change, real M1 led industrial output by 11 months both at the recession trough and the recent momentum peak. If the same lead-time applies from the January real M1 trough, the six-month change in industrial output should bottom in December. (The average lead historically has been shorter, so an earlier turnaround is possible.)

The OECD leading index turned only two months before industrial output at the recession trough and by three months at the recent growth peak. A December bottom in industrial output momentum, therefore, could be presaged by a trough in the leading index in September or October.

The OECD leading index is widely monitored by market participants, with a July reading due on 13 September. The above analysis suggests that this number, and possibly also figures for August and September, will be weak.

The view here remains that a "double dip" will be avoided but markets are likely to have to negotiate more downbeat economic data over coming weeks.

After the Lehman failure in September 2008 the view here was that central banks should embark on "quantitative easing", in the sense of direct purchases of assets, ideally from the non-bank private sector, in order to boost the broad money supply and reliquefy frozen credit markets. A severe shortage of money was developing, threatening economic freefall, as bank credit creation stalled and investors attempted to rebalance portfolios in favour of cash – put differently, increased money demand was depressing the velocity of circulation. Large-scale Federal Reserve securities purchases from late 2008, emulated belatedly by the Bank of England from March 2009, succeeded in alleviating the monetary imbalance both by expanding the money supply and stabilising markets, thereby slowing the "dash for cash". Faster growth of G7 broad and, particularly, narrow money, M1, from late 2008 confirmed that monetary conditions were improving, laying the foundations for a solid recovery in global economic activity starting in the spring of 2009.

With global momentum slowing recently, and fears growing about the impact of coming fiscal tightening, there are calls for central banks to engage in a further burst of "QE". In contrast to late 2008, however, there is little evidence that the global economy is being constrained by a shortage of liquidity. Broad money, admittedly, has been sluggish over the last year, with US M2 and UK M4 (on the Bank of England's preferred definition) rising by 2.0% and 1.2% respectively in the 12 months to July. The demand to hold money, however, has been reduced by negative real short-term interest rates and a revival of risk appetite. Velocity, in other words, has recovered – by 2.1% and 4.7% in the US and UK in the year to the second quarter (calculating velocity as nominal GDP divided by M2 or M4). Reflecting reinvestment of "safe-haven" cash, inflows to US and UK mutual funds have been strong, amounting to 4.7% and 2.5% of respective broad money stocks in the 12 months to July. (The latest UK figures, released today, show a £2.2 billion retail inflow in July alone, the largest since November – see chart.) Broad money, moreover, has reaccelerated over the latest three months, with US M2 growing by 5.4% annualised and UK M4 by 5.6%. Narrow money has also picked up, suggesting that economic momentum will revive in late 2010 (see second chart in Wednesday's post).

QE proponents argue that, even if there is no current monetary shortage, further action is warranted as insurance against the "tail risk" of a second recession leading to Japan-style deflation. An additional monetary boost, however, would involve its own risks and costs. One probable side-effect would be a further surge in commodity prices – "QE1" contributed to a 66% rise in industrial raw material costs during 2009. This would raise G7 inflation and lower real income expansion, thereby offsetting the direct boost to demand from monetary stimulus. Higher material prices had limited dampening impact on global growth in 2009 because they allowed commodity-producing countries to increase spending. This is much less likely now, since many of these commodity producers are in danger of "overheating" and will be forced to tighten monetary policies in the event of further stimulus from rising export prices. Even if central banks could be sure that more QE would provide a net boost to global growth, the wisdom of attempting to "fine tune" normal cyclical fluctuations is questionable: stimulus might arrive in early 2011 just as the economy is naturally regaining momentum, leading to excessive expansion and pressure for an abrupt policy reversal.