Combined industrial output in the G7 and seven large emerging economies (the "E7") moved above its pre-recession peak in July – see first chart. US and Chinese data suggest a further gain in August. Output fell by 14% between February 2008 and February 2009 and it has taken 17 months to recapture the loss – not quite a V-shaped recovery but close.

The heavy lifting, of course, has been performed by emerging economies, with the E7 contributing 9 percentage points of the 16% recovery in combined output from the February 2009 low – second chart. E7 output is 15% above its pre-recession peak and 1% higher than its log-linear trend since 2000 – a positive "output gap" is reflected in rising domestic inflationary pressures.

G7 plus E7 industrial output continues to track the path of G7 production during the mid 1970s recession and subsequent recovery – see previous post and third chart. (G7 output was a good proxy for global activity in the 1970s, when the E7 were much smaller and / or locked out of world trade.) This comparison suggests a significant near-term slowdown in growth but no "double dip" – a scenario consistent with recent monetary trends.

According to the CPI, clothing and footwear prices fell by 1.7% in the year to August. The alternative RPI clothing and footwear index, by contrast, rose by 6.3%. The difference is large enough to affect an assessment of economy-wide inflation – the headline 12-month CPI rise would have been 3.5-3.6% rather than 3.1% in August if the clothing and footwear component had matched the increase in the RPI measure.

The technical explanation for the difference is that the CPI uses geometric averaging to combine price movements of individual items, while the RPI uses arithmetic averaging. A non-technical explanation is that the CPI assumes that consumers are expert at shopping around for best value – so expert that they can obtain the same volume of clothing and footwear as a year ago while reducing their spending by 1.7%, despite a 6.3% rise in label prices.

This stretches credulity. If the same volume could be bought for 1.7% less, it would be reasonable to expect total cash spending on clothing and footwear to be little changed from a year ago. Retail sales figures, however, show a 6.4% rise in turnover in textile, clothing and footwear stores in the year to August. Based on the 1.7% CPI fall, this suggests an increase of 8.2% in the volume of purchases – implausible when overall consumer spending has been growing weakly.

While difficult to prove, the 6.4% rise in cash spending is likely to have been driven by higher unit costs rather than a surge in consumer demand for clothing and footwear. The 6.3% increase in the RPI clothing and footwear index, in other words, is probably a better reflection of consumers' experience than the 1.7% decline in the CPI measure, in turn implying that the headline CPI understates true cost of living inflation.  

Official intervention to weaken a currency is more likely to succeed when the exchange rate is overvalued relative to "fundamentals" and investor sentiment is at a bullish extreme, implying that opposing buyer power has been exhausted. These conditions do not apply to the yen currently, suggesting that massive, unsterilised intervention will be required to stem the currency's rise. A consequent large increase in the Japanese monetary base would improve prospects for global equities.

A possible further rise in the yen was flagged in a post in May, which argued that the currency was undervalued, in contrast to prevailing investor opinion. Subsequent appreciation has, apparently, hardened the consensus belief – a net 72% of fund managers now regard the yen as overvalued, a record high and up from 51% in May, according to Merrill Lynch.

Japan's real effective exchange rate, however, is close to its long-term average – see first chart. Japan's high real interest rates, moreover, justify the currency trading at a premium to a long-run competitive level – the implied future depreciation back to this level would then offset the interest advantage of holding yen. Japanese 10-year real yields are 2.0% versus 0.6% in the US, 1.2% in Germany and zero in the UK (using nominal government yields minus the current rate of harmonised CPI inflation).

Claims of yen overvaluation are also at odds with balance of payments trends, with Japan's surplus on the current account and net direct investment flows rising to 2.3% of GDP in the year to June from 0.3% in the previous 12 months – second chart.

With fundamentals supportive, and little evidence of a major overhang of long positions to be "shaken out", yen suppression is likely to require a prolonged campaign of large-scale, unsterilised intervention. Even this could prove fruitless, as recent Swiss experience shows. The attempt to weaken the yen, moreover, could create conflict with the US authorities, hastening the Federal Reserve's adoption of "QE2".

The "battle of the yen", therefore, could be the trigger for renewed central bank monetary base expansion, adding to the picture of an improving liquidity backdrop for markets and suggesting further strength in equities, commodities and other "risk" assets in late 2010.

The OECD's G7 leading indicator index fell by a further 0.4% in July, resulting in the six-month rate of change turning negative – see first chart. The index suggests that industrial output will flat-line or weaken into late 2010.

Based on an earlier slowdown in G7 real narrow money, M1, the OECD measure may decline further in August and September – see previous post. Recent M1 reacceleration, however, may presage a trough in the leading index this autumn, in turn implying that the recovery in industrial output will resume by early 2011.

In contrast to the G7 measure, a leading index covering seven large emerging economies (the "E7") rose by 0.4% in July. The six-month change slowed further but remains consistent with respectable output expansion – second chart.

While the G7 index registered a larger monthly fall in July, E7 monthly momentum seems to be stabilising – third chart. This could be significant since the E7 change led that of the G7 by a month at the trough of the recession and by two months at the 2009 growth peak. Stabilising E7 monthly momentum, in other words, could be a precursor of a slower decline in the G7 index, consistent with the autumn trough suggested by monetary trends.