The spring slowdown in global industrial momentum predicted by real narrow money and, more recently, the OECD's leading indices should be confirmed by April manufacturing purchasing managers' surveys. The slowdown was beginning before the Great Hanshin earthquake but has been exacerbated by ensuing supply disruption.

The charts show G7 PMI new orders with, respectively, Korean manufacturing expectations and the world earnings revisions ratio (i.e. the net proportion of equity analysts' earnings estimates that have been revised up since the prior month). Korea is a bellwether of the global industrial cycle while analysts' earnings revisions partly reflect information on trading conditions received from company contacts. Both indicators suggest an extension of the March decline in PMI orders.

A previous post suggested that a further rise in US bank reserves implied by the Fed completing QE2 would be offset by a fall in Japanese reserves, as the temporary boost from foreign exchange intervention and emergency lending to the banking system unwound. The surge in G7 reserves since early February – a contributor to recent strength in "risk assets" – might, therefore, end before QE2 itself. The Bank of Japan's liquidity withdrawal, meanwhile, might support the yen.

This scenario seems to be playing out. Japanese bank reserves have fallen by ¥6.0 trillion, or $81 billion, from a peak in late March versus a $95 billion rise in the US from the same date (as of last week) – see chart. The yen's effective exchange rate has rallied since early April, though partly in reflection of generalised US dollar weakness.

Hopes that the Great Hanshin earthquake would force the Bank of Japan to embark on massive Fed-style QE have been disappointed. A proposal to increase the "asset purchase program" (dominated by collateralised lending to the banking system rather than direct securities purchases) by a modest ¥5 trillion was defeated by eight votes to one at today's policy board meeting. Japanese reserves may decline further as the sterilisation of last month's intervention continues and banks' demand for funds normalises.

The 0.5% rise in GDP in the first quarter is stronger than it looks because of a large drag from the construction sector that should reverse in the current quarter. Outside construction, the economy has continued to recover over the autumn and winter, consistent with labour market data showing a rise in aggregate hours worked.

Key points:

• Combined services and industrial output, accounting for 93% of GDP, rose by 0.8% in the first quarter, more than recouping a 0.4% fourth-quarter loss. Monthly estimates, moreover, imply that March output was 0.3% above the first-quarter average, so the second quarter may record a 0.3% gain even if activity is static between March and June – see chart.

• Construction output fell by 4.7% in the first quarter following a 2.3% fourth-quarter decline, subtracting 0.3 percentage points from GDP growth given its 6% weight (i.e. GDP would have risen by 0.8% if construction activity had remained stable). This reflects carry-over from December's bad weather disruption, with monthly data indicating a strong rebound in February / March. Construction new orders lead output and reached a new recovery high in the fourth quarter, suggesting that output will, at the least, regain its third-quarter level. A return to this level in the current quarter would boost GDP growth by 0.3 percentage points (on top of the 0.3 point base effect from services / industrial output).

• A reasonable guide to the underlying path of the economy is the 2.0% rise in gross value added excluding North Sea oil and gas production in the year to the first quarter. (The construction distortion is smaller in the year-over-year numbers because activity was similarly depressed by bad weather in early 2010.) This may seem modest but early GDP numbers during recoveries have historically been revised up while trend economic growth may be only about 2% per annum (rather than the 2.35% assumed by the Office for Budget Responsibility).

• The notion that the economy has been growing at or slightly above trend is consistent with a steady rise in aggregate hours worked and an erosion of spare capacity reported in business surveys, including the Bank of England's agents' survey.

• Confirmation that the economic recovery remains on track ought to, but may not, prompt the MPC to begin the policy tightening its February Inflation Report implied was necessary to bring inflation back to target over the medium term.

The April CBI industrial trends survey signals that economic "rebalancing" is being hampered by a shortage of domestic manufacturing capacity, a conclusion also suggested by a Bank of England agents' investigation released last week. With firms struggling to keep pace with demand, the official policy of suppressing the exchange rate in order to stimulate manufacturing risks boosting inflation rather than economic growth.

The CBI survey reported a surprise surge in the percentage of manufacturers citing plant capacity as a constraint on output from 16% in January to 29% in April – the highest since 1988. The percentage working below a normal capacity level, meanwhile, fell to 55%, the lowest since July 2008 and slightly below the long-term average (of 56.5% since 1985) – see first chart.

Recruitment difficulties are also increasing: the percentage citing skilled labour availability as a constraint on output rose to 12% from 7% in January – second chart.

The implication that manufacturing is already running at full capacity tallies with a Bank of England agents' survey on imports, showing that firms have increased their use of imported inputs over the last three years despite sterling's depreciation, reflecting the relative cost and lack of availability of domestic substitutes.

With no slack, competitive pressures are weak, resulting in manufacturers passing through cost increases in full. The net percentage of CBI firms planning to raise prices reached 36% in April, the highest since 1990, suggesting a further pick-up in CPI goods inflation – third chart.