The Food and Agriculture Organisation food commodities price index – covering meat, dairy products, cereals, oils and fats, and sugar – rose by a further 7% in sterling terms in September, pushing annual growth up to 29% from 23% in August. This suggests upside risk to the forecast in a previous post that CPI food inflation will reach an annual 7% by late 2010 – see chart.

CPI food inflation rose from 3.0% in July to 3.9% in August. A further increase to 7% would add 0.3 percentage points to headline CPI inflation, given food's 9.6% weight in the basket. The headline rate was 3.1% in August.

A further boost is possible via the "catering services" (i.e. restaurants and cafés) component, with a 9.8% CPI weight. A rise in annual inflation to 4% from 3.1% in August would add 0.1 percentage points to the headline CPI rate, for a total 0.4 point impact.

Petrol prices have dampened CPI inflation recently and base effects are favourable until next spring but crude oil prices are climbing again. So are wholesale gas costs – Ofgem this week suggested that domestic gas bills will rise by 13% by next spring, above the 5% increase assumed by the Bank of England in the August Inflation Report. With a 2.5% weight, this would boost the headline CPI by 0.3 percentage points.

The latest survey by the Bank's regional agents, meanwhile, confirms earlier intelligence that most firms plan to pass on the coming VAT hike in full. The Bank estimates that this will add more than 1 percentage point to annual CPI inflation in 2011 but the effect is likely to be felt sooner as firms front-load increases.

These developments suggest significant upside risk to the Bank's forecast that inflation will stabilise at about 3% before starting to fall next spring. A rise to 4% is possible if the various adverse effects coincide. A renewed inflation increase would make it difficult for the MPC to embark on "QE2" asset purchases; doves may wish to press their case at next week's meeting before the window for action closes.

Chinese industrial output may be reaccelerating after a temporary slowdown. Adjusting for seasonal variation, the current and future new orders indices in the Market News International (MNI) business survey rose in September – see first chart.

The rebound has been accompanied by a pick-up in input cost and output price pressures. The MNI current and future prices received indices rose sharply this month, suggesting a reversal of the recent slowdown in producer price inflation – second chart.

The weekly food produce price index, meanwhile, continues to climb, signalling a likely further rise in CPI food inflation from an annual 7.5% in August – see previous post and third chart.

Markets have been partying in anticipation of "QE2". Will the Chinese authorities douse the celebrations?

August monetary statistics are encouraging, suggesting a continued economic recovery and arguing against "QE2":

• The Bank's preferred broad money measure, M4ex (i.e. M4 excluding money holdings of "intermediate other financial corporations"), rose by a chunky 0.8% in August and has grown at a 4.5% annualised pace over the last three months.

• Within M4ex, money holdings of private non-financial corporations (PNFCs) gained 0.9%, pushing annual growth up to 5.0%. The corporate liquidity ratio – sterling and foreign currency deposits divided by borrowing – rose to its highest level since the second quarter of 2007. Excluding property companies, the liquidity ratio is close to the top of its range in recent years, supporting hopes of a further pick-up in business investment and hiring – see chart.

• M4ex lending rose by 0.3% following a 0.3% gain in July, resulting in three-month growth turning positive (0.8% annualised). This improvement mainly reflects financial-sector credit but lending to PNFCs also rose marginally in August.

• The QE2 crew will point to still-low annual growth in M4ex – 1.6% last month after 1.2% in July. They neglect that broad money velocity is rising fast – by 4.3% in the year to the second quarter, allowing nominal GDP to expand by 5.7%. When real interest rates were last negative for a sustained period in the 1970s, velocity rose by a cumulative 38.6% over six years, or 5.6% annualised. A similar trend is plausible now, suggesting that broad money expansion of 1-2% per annum is more than sufficient to finance sustainable economic growth of about 2.5% with 2% inflation.

• Monetary expansion continues to be supported by an influx of foreign funds – overseas investors bought £9.5 billion of gilts and Treasury bills in August, bringing the year-to-date total to £62.1 billion, while "monetary financial institutions' externals" contributed £15.1 billion to the increase in M4. 

The big news in today's national accounts release is a fall in the household saving ratio to just 3.2% in the second quarter from 5.5% in the first (revised down significantly from 6.9%). This will increase fears that the recovery is at risk from renewed weakness in consumer spending as households attempt to rebuild their finances.

Such worries are overblown, for two reasons. First, the fall in the ratio between the first and second quarters partly reflected a large drop in dividend income, which is likely to prove temporary given strong corporate free cash flow. (BP suspended its dividend last quarter but is expected to resume payment in early 2011.)

Secondly, the fall in household saving was more than offset by a decline in government current borrowing and higher corporate retained earnings. Accordingly, the national saving ratio (i.e. the proportion of gross national income not consumed) rose in the second quarter, though remains low – see chart.

Encouragingly, companies are using higher saving to expand capital spending, circumventing the banks – business investment was revised up to show a 0.7% increase last quarter after a 7.9% first-quarter gain. The fall in government borrowing, meanwhile, may temper worries about future tax rises, encouraging households to maintain a lower saving ratio.