Eurozone monetary trends continue to suggest a significant slowdown in growth in core economies and a recession in the periphery.

Narrow money M1 is a better economic leading indicator than the broader M3 measure; it weakened before the last recession and surged before the recovery. M1 comprises currency in circulation and overnight deposits – forms of money more likely to be related to economic transactions. Six-month M1 growth slowed from 3.3% (not annualised) in June to 1.1% in December. With CPI inflation picking up, real M1 is now contracting. (All figures are seasonally adjusted.)

The aggregate figures conceal an unprecedented divergence between core and peripheral economies. The ECB publishes a country breakdown of overnight deposits but not currency. Deposits in a core grouping of Austria, Benelux, France and Germany rose by a real 1.8% in the six months to December, down from 5.0% in June but still respectable. In Greece, Ireland, Italy, Portugal and Spain, however, they fell by 4.1% – larger than the decline preceding the 2008 recession.

The first chart shows the core / peripheral split while the second gives a country breakdown of the latter grouping. Real deposits are falling in all five cases, with Greece registering the largest decline but Portugal recently catching up. Among the core grouping (not shown), contraction in Belgium is counterbalanced by buoyancy in the Netherlands, with moderate growth in Germany and France.

Global industrial growth picked up in late 2010 but is expected to peak this spring, based on monetary trends – see previous post. This peak should be foreshadowed by a topping-out of forward-looking components of business surveys, such as the US ISM manufacturing new orders index. (The January ISM survey is released on Tuesday.)

Interestingly, an imminent softening in ISM new orders is also suggested by a comparison of the recent behaviour of the index with prior recoveries – see first chart. (The four-cycle average is based on movements around troughs in January 1958, December 1974, January 1991 and January 2001. The index reached another major low in June 1980 but the subsequent recovery aborted early, so this cycle is excluded from the comparison.)

US regional manufacturing surveys for January have been strong but hint at a peak in order flows – second chart. (The Dallas Fed survey is released on Monday so the latest survey averages use December readings.)

Korea is often a bellwether of the global industrial cycle. The Federation of Korean Industries manufacturing survey for January reported weaker expectations – third chart. This may reflect some cooling in China in response to recent stepped-up policy tightening. China's PMI new orders index fell in December and may ease further in January.

Current global monetary trends are not suggesting serious economic weakness while the ISM new orders four-cycle average strengthens again later in 2011. Investor behaviour, however, typically turns more cautious around peaks in economic momentum, even when the subsequent slowdown proves to be a "pause to refresh".

The EU Commission's UK consumer survey for January will increase MPC worries about inflationary expectations becoming detached from the 2% target.

The net percentage of consumers expecting faster price rises over the next 12 months increased to 42, above the 2008 peak of 39 and the highest since 1994. The net percentage reporting higher prices over the last 12 months climbed to 40, though reached 60 in 2008 – see first chart.

The second chart shows CPI inflation together with the sum of the two survey responses. (In theory, the backward-looking net percentage should be related to current inflation while the forward-looking response will gauge the expected rise or fall, so the sum should be a measure of one-year-ahead inflation expectations.)

The combined measure leads inflation and is approaching the 2008 peak, which foreshadowed a CPI headline rate of 5.2%. Expectations and inflation itself, of course, fell sharply in 2009, reflecting the recession and a collapse in commodity prices; the current overshoot is likely to prove more sustained.

Bank of England Governor Mervyn King now expects CPI inflation to reach 4-5% over the next few months. Even if Drs Sentance and Weale are able to convince a majority of the MPC (presumably not including the Governor) to vote for tightening, Bank rate is unlikely to rise beyond 1%. The real level of Bank rate, therefore, is heading deeper into negative territory and could reach minus 4.5% – the lowest since 1977.

Real policy rates moved from positive to negative in 1970 and again in 1974, with both movements followed by a large fall in the effective exchange rate – see first chart. The two currency declines were separated by a year-long period of stability, similar to the recent sideways movement. The second chart superimposes the fall in sterling from a December 1971 peak on the recent decline.

Will increasingly negative real rates scare off foreign investors and lead to a 1975-style second leg down for sterling, thereby further boosting import prices and entrenching the current inflation overshoot?

After two heavy months, public sector borrowing fell back sharply in December, to its lowest seasonally-adjusted level since November 2008 – see chart. If the adjusted run-rate in the final quarter of 2010-11 matches the average for the first nine months, full-year borrowing will be £146 billion, below the Office for Budget Reponsibility's November forecast of £148.5 billion. A larger undershoot, indeed, is possible, partly reflecting additional receipts from the VAT hike to 20% (forecast to raise £2.85 billion in 2010-11).

GDP is provisionally estimated to have fallen by 0.5% in the fourth quarter, against market expectations of a 0.5% rise. The estimate is unusually uncertain because of December's bad weather disruption and a change in Office for National Statistics (ONS) procedures to try to include the impact – the preliminary number normally incorporates limited information for the final month of the quarter. The ONS thinks that GDP would have been "flattish" without the bad weather.

The ONS assessment is probably too downbeat. As explained below, it may have overestimated the weather hit to December GDP while data for October / November suggest that the economy would have expanded by about 0.25% in the absence of the disruption. The bulk of the output loss, moreover, is temporary and will be recouped in early 2011, boosting first-quarter GDP.

Official GDP figures are quarterly but a monthly estimate can be constructed from data on industrial, construction and services output (the November services number was also released this morning) – see first chart. This reveals that the average level of GDP in October and November was 0.1% higher than in the third quarter. In the absence of the bad weather, GDP would probably have risen in December – the PMI manufacturing new orders and services new business indices rose to four- and five-month highs respectively in November. So GDP was on track for a quarterly gain of about 0.25%.

To generate its estimate of a 0.5% quarterly fall, the ONS has incorporated a 1.8% decline in December. There are two reasons for thinking that this may be too large. First, it exceeds the declines in January and April 2010, of 1.7% and 1.4%, associated with bad weather and air transport disruption due to volcanic ash respectively. Secondly, the December estimate probably relied on information for the early and middle parts of the month when disruption was most severe.

The January 2010 weather-related fall was followed by a strong rebound that pushed GDP temporarily well above the underlying trend – first chart. The bulk of the lost output, therefore, was recouped by March, implying little effect on first-quarter GDP. The current distortion to the quarterly GDP profile is much larger because the hit and recovery occur in different quarters. If monthly GDP changes over January-March 2011 were to mirror those in the three months following the January 2010 slump – a reasonable scenario – GDP would increase by 1.2% in the first quarter.

The second chart updates a comparison of the 2008-09 recession and recovery with prior cycles. The current upswing continues to resemble that of the early 1980s, with last quarter's GDP fall reversing a slight overshoot of the earlier path in the third quarter. A strong first-quarter rebound would maintain the similarity.

Today's number is manna from heaven for stale economic bears and MPC members seeking new excuses for interest-rate inaction – "one-off" distortions, it appears, only ever work in the doves' favour. The underlying reality is that the economic recovery is probably proceeding at a moderate pace, with a slowdown from above-trend growth in mid 2010 consistent with recent monetary trends.