The issue of whether China is heading for a “hard landing” is as important for global economic prospects as events in the Eurozone.

Market pessimism on China was boosted by weak headline PMI results for November. This weakness, however, may be attributable to seasonal factors: the official manufacturing PMI new orders index, seasonally adjusted within Datastream, was little changed between October and November – see last week's post.

The bear case seemingly received further support from news today that industrial output growth slowed from an annual 13.2% in October to a lower-than-expected 12.4% in November. An attempt to back out a seasonally-adjusted level index from the official data, however, suggests that the recent decline reflects base effects, i.e. large output increases a year ago dropping out of the annual comparison. The six-month rate of expansion, by contrast, firmed again in November, having bottomed in August. This pick-up follows an earlier revival in a leading indicator derived from OECD data – an update of this indicator will be available on Monday.

Inflation news today, meanwhile, was better than expected, with annual CPI inflation down to 4.2% and PPI inflation slumping to 2.7% – consistent with a recent sharp drop in the PMI input prices index discussed in the previous post.

The forecast here that faster global real money supply expansion would provide an economic lift in late 2011 is supported by recent G7 consumer demand indicators.

G7 retail sales volume rose by an estimated 1.0% in the three months to October (i.e. 4.2% annualised), regaining its 2007 pre-recession peak. Industrial output is lagging as firms adjust inventories but should revive in early 2012 if solid demand is sustained. (The G7 retail sales measure is calculated by the OECD and has been updated for September and October using national data.)

The recent tentative recovery in the G7 manufacturing new orders index fits the story, with earlier weakness preceded by a temporary fall in retail sales.

November vehicle sales figures provide more evidence of consumer resilience, although the G7 total remains well below the pre-recession peak.

Consumer purchasing power is being supported by a slowdown in inflation as food and energy price pressures ease.

The “MPC-ometer” model for predicting monetary policy decisions suggested that further easing would be announced in November. The Committee, in the event, stood pat. Was the model wrong, or the MPC?

The question is legitimate because the forecast issued in the November Inflation Report seemed to argue strongly for action. The mean projection for CPI inflation in two years’ time assuming unchanged policy was well below the 2% target at 1.29% – the lowest since February 2009.

The judgement here is that such an undershoot is as unlikely now as it was back then. If the MPC believes its forecast, however, why hasn’t it taken preventative action?

The November minutes suggest that members held back for two reasons – the scale of the current inflation overshoot and a belief that it would be technically difficult to increase the rate of gilt purchases.

The first reason is odd given the MPC’s proclivity until now to dismiss high current inflation as the result of bad luck. An inflation overshoot, moreover, did not prevent aggressive easing in early 2009. (The headline CPI rate was lower, though, at 3.2% in February 2009 versus 5.0% in October 2011.)

The second reason – that QE cannot be accelerated – is even flimsier. Monthly gilt purchases could be boosted by about £15 billion by the Bank coming to an agreement with the Debt Management Office to absorb new issuance – DMO gross gilt sales have averaged £14.9 billion a month so far in 2011-12. The MPC, moreover, could extend the buying programme to non-government assets, following the example of the Federal Reserve (agency mortgage-backed securities), ECB (covered bank bonds) and Bank of Japan (commercial paper, corporate bonds and exchange-traded equity index funds).

The “MPC-ometer” may have become temporarily less reliable given the Committee’s inconsistent behaviour. Its prediction for Thursday’s meeting is either a 25 basis point cut in Bank rate to 0.25% or a £50 billion expansion of QE.

Food prices have delivered a significant boost to UK headline inflation in 2011 but are on course to be a restraining influence in 2012, implying welcome support for consumer purchasing power.

The daily CRB spot foodstuffs index has fallen by 15% from a peak in April, reaching its lowest level since December.
The CRB index is a reasonable guide to the more comprehensive monthly Food and Agriculture Organization (FAO) food commodity price index. The annual rate of change of the FAO index, expressed in sterling terms, leads UK CPI food inflation by about six months.
Based on this relationship, a post in September 2010 suggested that CPI food inflation would reach 7%, contributing to headline inflation overshooting Bank of England and consensus forecasts. The peak annual increase, in the event, was 6.5% in June 2011, with food inflation slowing to 4.6% by October.

Assuming no change from the current level, the FAO index will register an annual fall of about 10% by early 2012. This would be consistent with CPI food inflation subsiding to about 1% by mid 2012. Such a decline would cut 0.4 percentage points from the headline inflation rate (i.e. 4.6% minus 1% times food’s 10.3% weight in the CPI basket).

The forecast here that global economic momentum would revive in late 2011 in lagged response to faster real money supply expansion received support from data last week – see Thursday’s post. Monetary trends continue to suggest that consensus gloom is misplaced: six-month growth of real narrow money in the G7 and emerging “E7” economies was stable at 5.1% (i.e. 10.5% annualised) in October – the highest since August 2009.

As previously discussed, the positive signal from real money received provisional confirmation from an upturn in a proprietary leading indicator derived from the OECD’s country leading indices, which combine information on a range of forward-looking variables. Confidence in the forecast would be strengthened by a further rise in the indicator – an October reading will be available next Monday.

Global monetary strength conceals major divergences between countries and regions. Faster real narrow money growth in the US than the Eurozone has been reflected in recent economic and equity market outperformance. Monetary trends have also been weak in the E7 economies but are beginning to revive in response to central bank easing and a food-driven fall in inflation, hinting at better stock market performance in 2012.

Friday’s news that the US unemployment rate fell to a new recovery low of 8.6% in November was instantly dismissed by gloom-mongers as the result of discouraged workers leaving the labour force and an early Thanksgiving boost to hiring, to be reversed in December. The improvement, however, was confirmed by a parallel recovery low in the net percentage of respondents assessing jobs as hard to find in the November Conference Board consumer survey.

The gloomsters are in full chorus in the UK, where downbeat forecast revisions by the unproven Office for Budget Responsibility have fuelled fears of a “double dip” accompanied by soaring unemployment. Real money trends, however, were improving before QE2 was launched and will receive further support from slowing inflation – see previous post. Business surveys, though weak, have yet to suggest economic contraction while labour demand is holding up, judging from the tallies of online vacancies compiled by Monster and Reed.