The economic recovery is approaching its second birthday – global industrial output bottomed in February 2009. The upswing has proceeded in three phases, with growth rising to a peak in early 2010, slowing sharply over the summer and autumn and picking up again late last year.

Investor behaviour typically turns more cautious around peaks in economic momentum, even when the subsequent slowdown proves to be a "pause to refresh", as recently. Last year's growth "wobble" may have contributed to the Eurozone sovereign liquidity crisis as well as triggering a temporary sharp set-back in equities and strength in the traditional currency "safe havens", the yen and Swiss franc.

A key issue for investors, therefore, is how long the current reacceleration phase will last, since the next momentum peak may mark the onset of another bout of weakness in equities and other "risk" assets. Based on the analysis below, the working hypothesis to be adopted here is that this peak will occur in April or May.

The first chart shows six-month changes in G7 industrial output and the OECD's leading index. Output growth peaked in January 2010 and troughed in November. The leading index turned 2-3 months earlier, providing effective early warning of only 1-2 months allowing for a publication lag of over one month.

The chart also shows a "leading indicator of the leading index", based on the latter's short-term momentum. This is more useful in signalling turning points, with a typical lead time of 5-6 months (4-5 months effective). The indicator reached a trough in June 2010, with this apparent on publication of July data in early September – roughly coincident with the start of another "risk-on" period in markets.

The double-lead indicator was still rising as of November, the latest available month. Allowing for the 5-6 month lead, this suggests no peak in G7 industrial output growth before April at the earliest.

The second chart brings monetary trends into the analysis. G7 real narrow money leads output by 6-12 months, implying that it usually moves ahead of the double-lead indicator. Six-month expansion bottomed in January 2010, 10 months ahead of industrial output and five months before the indicator. This was the basis for a forecast in a post in July that the global economy would reaccelerate from late 2010.

Real money growth, however, has been slowing from a high in July last year, suggesting a peak in output expansion between January and July 2011. As just explained, the double-lead indicator rules out January-March, narrowing the window to April-July. Assuming the same lead time from real money to the economy as at the recent trough (i.e. 10 months), output expansion will peak in May.

A final piece of evidence is the relationship between the double-lead indicators for the G7 and E7 (i.e. seven large emerging economies), shown in the third chart. The E7 indicator led its G7 counterpart by 1-2 months at the two most recent turning points. It appears to have peaked in October, suggesting that the G7 indicator reached a high in November or will in December. This, in turn, would imply an output growth peak in April or May, allowing for the 5-6 month lead.

The hypothesis of a slowdown in economic momentum from a spring peak will be maintained unless G7 real narrow money expansion stages an early recovery. Conviction in the forecast will be strengthened if the G7 double-lead indicator falls in December (released on 14 February) or January. If the scenario is correct, recent strength in business surveys and earnings revisions should moderate moving into the spring.

The January CBI quarterly industrial trends survey provides further evidence that the MPC is losing control of inflationary expectations. A net 33% of firms reported plans to raise prices (after seasonal adjustment) – the highest, except for one month in 2008, since 1984.

The price-raising balance correlates with CPI goods inflation, suggesting that this will rise from an annual 3.5% in December to about 5% in early 2011, sufficient to add 0.8 percentage points to the headline CPI rate, given the 55% weight of goods in the basket – see chart.

The CBI balance relates to pre-tax factory-gate prices so the latest surge cannot be attributed to the January VAT hike. Rather, it reflects pass-through of recent and expected cost increases, with firms apparently confident that the MPC will tolerate the implied inflation overshoot.

Other notable features of the survey were a further strengthening of investment plans and a rise in capacity shortages, both consistent with the "output gap" in manufacturing being close to zero or even positive.

Housing market bears are out in force again, claiming that prices will fall by up to 10% this year. The bears have been cheered by a decline during 2010 (by 4% between January and December on the Halifax measure), although they failed to predict the prior stronger rally (10% from a low in April 2009).

The view here remains that there is no big overvaluation to correct, with the national rental yield now close to its long-run average, partly reflecting recent strong growth in rents – see first chart. This is a superior valuation metric to the house price to earnings ratio, the "equilibrium" value of which has risen over time, reflecting factors such as improving quality, the pressure of an expanding population on constrained supply and a high income elasticity of demand for housing.

The December RICS survey showed a net 39% of estate agents reporting lower prices, seemingly supporting the bears. Both the reported and expected balances, however, recovered while the new buyers minus sellers indicator (i.e. the difference between the new buyer enquiries and selling instructions balances), which leads prices, turned positive for the first time since December 2009 – second chart.

Rising inflation is feeding through to wage trends, judging from November average earnings data, showing 2.4% annual growth in regular pay, up from 1.0% a year earlier and the fastest since February 2009.

The pick-up in pay growth has been stronger in the private sector, with the November annual increase of 2.4% up from just 0.1% a year before.

Earnings growth, of course, is still far beneath inflation, resulting in a major squeeze on real wages. The gap, however, may reflect the normal lag between inflation and pay. The current shortfall of wages growth is the mirror-image of late 2008 and 2009, when pay trends took time to respond to a sharp inflation decline – see first chart.

Elsewhere in today's labour market report, the labour force survey measure of employee numbers continued to weaken, reversing a strong rise last spring, but a recovery in vacancies suggests a stabilisation or improvement in early 2011 – second chart. The vacancies rise, however, is explained by temporary hiring in connection with the 2011 Census, with private-sector job openings static in recent months.

Worries about the near-term impact of public-sector job losses may be exaggerated, with the Office for Budget Responsibility (OBR) forecasting that cuts will be back-loaded. Of a 330,000 fall in general government employment between 2010-11 and 2014-15, the OBR projects only 40,000 to occur by March 2012.

With the December rise to 3.7%, CPI inflation averaged 3.4% in the fourth quarter, representing another significant overshoot of the Bank of England's central forecasts of 3.2% in the November Inflation Report and 3.0% in August.
 
The 3.7% print was above a median forecast of 3.4%, according to Bloomberg, but in line with a projected profile for CPI inflation presented in a post last week. Inflation is now certain to move above 4% in early 2011, a prospect belatedly recognised by the consensus. Assuming no further rise in global commodity prices, the headline rate may reach 4.3% in February, remaining at or above 4% until late 2011.
 
While food and energy prices were the key upward driver in December, the Bank's forecasting miss also reflects stubborn core inflation, which continues to defy its prediction of a slowdown in response to economic slack and fading exchange rate effects. CPI inflation excluding energy, food, alcohol and tobacco firmed to 2.9%, a six-month high.
 
It has recently become fashionable to quote the tax-adjusted inflation measures, CPI-CT and CPIY, which are running well below headline inflation, at 1.9% and 2.0% respectively (up from 1.5% and 1.6% in November). CPI-CT is calculated at constant tax rates while CPIY excludes indirect taxes altogether.
 
These measures, however, understate "true" inflation because they are calculated on the assumption that indirect tax hikes are passed on in full to consumers. ONS research on the December 2008 VAT reduction from 17.5% to 15% indicated pass-through of only one-third. Assuming that one-half of the increase in VAT and other indirect taxes last year was reflected in the prices charged to consumers, inflation would now be about 2.8% had tax rates remained stable.
 
The current inflation overshoot should be viewed in a longer-term context. The consumer prices index for December was 4.4 percentage points above the level implied if the Bank of England had achieved 2% inflation since the target was switched to the CPI in December 2003, implying an average overshoot of 0.6% per annum. The RPIX measure (i.e. retail prices excluding mortgage interest costs) has exceeded the previous 2.5% inflation target by 5.3 percentage points over this period.
 
Advocates of a rise in interest rates are not "inflation nutters" but believe action is required to prevent an upward drift in inflationary expectations that would worsen the output-inflation trade-off, thereby depressing medium-term growth prospects.