Based on data covering 60% of the aggregate, G7 plus emerging E7 six-month real narrow money expansion slowed slightly further in January, having peaked in October 2012. Growth, however, is still respectable by historical standards, at an estimated 3.4% or 6.9% annualised – see first chart. Allowing for the typical half-year lead, this suggests that global economic momentum will peak in spring 2013 but remain solid into the summer.

Global activity is picking up on schedule in response to the revival in real money expansion between April and October last year. G7 plus E7 six-month industrial output growth rose to an estimated 1.2% (2.4% annualised) in December – the fastest since May. With real money now slowing, the gap between its rate of change and that of output is narrowing, indicating that “excess” liquidity available to flow into markets and lift asset prices is diminishing. According to research presented in a previous post, however, equity bear markets normally begin only after real money expansion crosses beneath industrial output growth.

The second chart shows six-month real money growth for countries that have released January monetary data. US real money expansion has slowed but remains relatively strong, consistent with the recent outperformance of US equities. Japanese growth is solid but the Bank of Japan’s stepped-up easing efforts have yet to give a further boost. A pick-up in Chinese real money expansion supported the global measure in January but may reflect a New Year timing effect, implying an unwind in February – see previous post. The final global reading for January will depend importantly on Eurozone monetary data to be reported on 27 February.

The shorter-term leading indicator followed here suggests that global growth will strengthen into the spring – see Monday’s post. The following charts provide some country detail.

The first chart shows indicators for the G3 plus the UK. The latest readings are all positive; between February 2010 and September 2012, at least one was negative in every month bar one (February 2012). The current pick-up, therefore, has breadth. Another standout is the speed of recent improvement in Japan.

The second chart separates out the big four Eurozone economies. This is less encouraging, with German buoyancy and Italian improvement contrasting with weakness in France and, especially, Spain. This divergence is also evident in real narrow money trends – see previous post. Without a balanced recovery, doubts about the sustainability of the Eurozone in its current form are likely to persist.

The final chart shows the six-month rate of change of the Journal of Commerce index* of industrial commodity prices together with a leading indicator for the emerging E7** countries, which drive incremental demand for raw materials. The continued rise in the indicator suggests that the recent rally in commodity prices will extend, in turn putting upward pressure on inflation rates globally later in 2013.

*Covering 18 materials used in manufacturing production including crude oil and natural gas.
**Defined here as BRIC plus Korea, Mexico and Taiwan.

A key summary measure of each Inflation Report is the Bank of England’s “mean” forecast for inflation in two years’ time based on unchanged policy. (The mean forecast incorporates upside and downside risks as well as the central projection.) Historically, a forecast above the inflation target has signalled a tightening bias to policy, and vice versa.

In today’s February Report, the two-year-ahead mean inflation forecast appears to be 2.3-2.4%* versus 1.80% in November. This is the highest since early 2011: the forecasts in February and May 2011 were 2.48% and 2.54% respectively – see chart. The MPC came close to tightening policy in early 2011; three members voted to hike rates between February and May.

The current MPC, of course, has no such bias. Indeed, the Report states that the Committee stands ready to provide additional stimulus without mentioning a possible need to tighten policy should the inflation outlook continue to deteriorate. This is likely to sustain the recent upward drift in longer-term inflation expectations, which are already barely consistent with the target. The MPC's nonchalance, in other words, risks undermining the (questionable) inflation / growth trade-off it seeks to exploit.

*Estimated from the fan chart; the precise number will be available next week.

UK consumer price inflation was stable at 2.7% in January but the forecast here remains for it to rise to more than 3.5% by mid-year and hold above 3% into 2014.

Sustained above-target inflation in recent years reflects a combination of a stubborn core trend and upward pressure on energy and food prices due mainly to rising emerging-world demand. Both should persist.

Core inflation can be measured by the annual change in the CPI excluding energy and unprocessed food adjusted for VAT changes and last year’s hike in undergraduate tuition fees. This was an estimated 2.3% in January and has been above 2% in 54 of the last 57 months – see first chart. Core inflation is expected to firm later in 2013 and in 2014 in lagged response to stronger money supply growth, based on the Friedmanite forecasting rule discussed in previous posts.

The near-term rise in inflation, however, will be driven by energy / food. Assuming no change to the current wholesale price, unleaded petrol should climb from 132 pence per litre in January to about 138 pence – second chart. Household energy bill inflation will increase further as tariff cuts in early 2012 drop from the annual comparison. Food price inflation may rise from 4.5% in January to 6-7% as higher input costs are passed on – third chart.

Energy and food are included in the CPI goods index, which should also capture most of the impact of recent exchange rate weakness. CPI goods inflation is forecast to rise from 1.9% in January to about 3.5% by mid-year, a scenario supported by CBI industrial firms’ price expectations – fourth chart. With goods accounting for 53% of the basket, this would be sufficient to lift the headline CPI rate to 3.5%, assuming stable services inflation.

The forecasting indicators employed here continue to suggest that the current pick-up in global economic growth will peak out in the spring. They are not yet warning of significant subsequent weakness, however.

The first chart below shows the six-month percentage change in G7 plus emerging E7 industrial output together with a leading indicator derived from the OECD’s country leading indicators, a December update for which was released today. This indicator continued to climb in December and has led turning points in industrial growth by an average of three months in recent years, suggesting that the current pick-up will extend at least through March.

The second chart superimposes a “leading indicator of the leading indicator” designed to give earlier warning of growth turning points – its average lead time has been five months. This double-lead measure edged lower for a second month in December. The October peak is consistent with global industrial growth topping out in March*.

A similar outcome is suggested by global real narrow money expansion, which has led economic cycle turning points by an average of six months and also peaked in October**, consistent with an April growth top – third chart.

Market prospects depend importantly on whether a spring growth peak is followed by a plateau or another slowdown – cycle downturns, even modest, have been associated with “risk-off” episodes in recent years. The indicators have yet to distinguish between these scenarios – both real money expansion and the double-lead measure remain at levels historically consistent with respectable economic growth. Some caution, however, may be warranted pending clarification.

*Data revisions have shifted the previously-reported September peak in the double-lead indicator.

**An early estimate of January real money growth will be available later this week and will be reported here.