The latest monetary statistics are consistent with a continuing business-led recovery but economic growth is likely to moderate from its recent strong pace:

• Broad money (i.e. M4 excluding intermediate other financial corporations) rose by 2.0% in the year to September and by 2.6% annualised during the third quarter. Growth remains slow by recent standards but must be assessed against a rising trend in velocity – up by about 4% over the last year versus an average decline of 0.5% per annum over the last half-century. (Note: monthly broad money figures show a rise of only 0.3% annualised in the three months to September but the Bank is reviewing its seasonal adjustments and recommends focusing on quarterly data.)

• Within broad money, holdings of private non-financial corporations rose by an annual 5.2% in September, up from 3.4% in June. With companies continuing to repay debt, the corporate liquidity ratio – sterling and foreign currency deposits divided by bank borrowing – reached its highest level since the second quarter of 2007. Excluding the property sector, the liquidity ratio is at a new record in data extending back to 1998 – see chart.

• Money holdings of households rose by an annual 2.8%, down from 3.0% in June. Growth continues to be restrained by a portfolio shift into mutual funds: net retail buying of unit trusts and OEICs totalled £25.3 billion in the 12 months to August, equivalent to 2.5% of household broad money (September figures are released next week). The recent slowdown may partly reflect a fall in the saving ratio.

• While nominal broad money trends remain satisfactory, faster price increases – due to the coming VAT hike and rising food and energy costs – may act as a drag on real expansion, implying less monetary stimulus for economic growth. Narrow money trends may be signalling a peak in economic momentum: annual M1 expansion slowed from 8.3% in June to 2.6% in September, although this partly reflects an unfavourable base effect and may prove temporary.

• Overseas investors bought a further £8.5 billion of gilts in September, bringing the year-to-date total to £62.7 billion – 48% of net issuance. Banks, by contrast, reduced their holdings slightly in August and September, possibly in anticipation of a "QE2" boost to their reserve positions at the Bank of England – higher reserves imply less need for gilt purchases to meet liquidity targets.

The net percentage of UK consumers expecting prices to rise at a faster pace over the next year is at a 25-month high, according to the October EU Commission consumer survey.

The net percentage reporting an increase in prices over the last 12 months also jumped and is well above its long-run average.

The forward-looking indicator usually leads swings in inflation so the latest rise is consistent with the forecast here of a pick-up in the headline CPI rate – see chart.



GDP growth of 0.8% in the third quarter should scotch any discussion of "QE2" at next week's MPC meeting. GDP has now recovered 40% of its loss between the first quarter of 2008 and the third quarter of 2009. Even assuming that growth slows to 0.4% in the fourth quarter, GDP will increase by 1.8% in 2010 versus a consensus forecast of 1.3% at the start of the year. Relative to the previous peak, GDP is higher than at the equivalent stage of the early 1980s recession / recovery.

Other points:

• A monthly GDP estimate derived from data on services and industrial output was 0.4% above its third-quarter average in September, implying positive "carry-over" into the current quarter – see first chart.

• Sceptics will point to the significant, and unsustainable, contribution to recent growth from construction and government services. Excluding these sectors, however, output still grew by 2.6% in the year to the third quarter.

• It is wrong to assume that coming public spending cuts imply a decline in government services output. To the extent that cuts fall on transfer payments and public sector wages, there is no impact. Government services output rose by 8.8% over 1992-97 despite a 5.5 percentage point fall in the public spending share of GDP between 1992-93 and 1997-98.

• Third-quarter GDP was 3.9% below its peak level in the first quarter of 2008, compared with a maximum decline of 6.5% in the third quarter of last year. At the equivalent stage in the early 1980s (i.e. in the fourth quarter of 1981, 10 quarters after the peak in the second quarter of 1979), GDP was 4.4% lower – second chart.



Are markets too focused on prospective monetary easing in the US and, possibly, the UK, neglecting policy restriction elsewhere?

China delivered a "surprise" interest rate hike last week but, in addition, the ECB has been "tightening by stealth". The expiry of long-term refinancing operations has resulted in a 19% contraction in the monetary base since late June, contributing to three-month Euribor moving above 1.0% versus a first-half average of below 0.7% – see first chart.

The Eurozone reduction has been the main driver of a 7% fall in the G7 monetary base over the same period. World equities have tracked the G7 base since the Fed launched "QE1" in late 2008 but a large gap has opened up recently, suggesting that markets have already priced in an additional injection of about $400 billion – second chart.

An important issue is whether the Fed chooses to sterilise the monetary base impact of the additional asset purchases it will, presumably, announce next week. "QE1" was accompanied by the introduction of the "supplementary financing programme" (SFP), under which the Treasury issues additional bills to soak up liquidity created by the Fed. The SFP has been static at $200 billion in recent months.

In a recent speech, Fed Chairman Bernanke referred to asset purchases providing stimulus by lowering longer-term interest rates rather than boosting the monetary base, suggesting that he would be comfortable with a fully- or partially-sterilised operation. A "QE2" initiative accompanied by an increase in the SFP would probably deliver less "bang for the buck" in terms of wider market impact.