The recession probability indicator discussed in earlier posts signals that the UK economy will return to growth by early 2010. The indicator is less gloomy than the latest Bank of England Inflation Report and suggests that the Treasury's forecast of a 1.25% rise in GDP in 2010 is achievable. However, a full recovery – in the sense of trend economic growth or higher – will require faster monetary expansion.

The indicator estimates the probability of the economy being in a recession three quarters ahead based on a range of monetary and financial inputs, including inflation-adjusted broad and narrow money supply growth, companies' liquidity ratio, three-month LIBOR, the yield spread between corporate and government bonds, share prices and the effective exchange rate. A recession is defined as an annual fall in GDP – a stricter interpretation than often employed.

The recession probability estimate began to climb in the second half of 2007 and reached a peak of 91% at the end of 2008 in the wake of Lehman's collapse – see chart. It fell back to 71% in the first quarter of 2009, however, and a further decline to 33% is indicated for the second quarter, using the latest values for the inputs.

Allowing for the nine-month lead, therefore, the indicator suggests a two-thirds chance that annual GDP growth will be positive in the first quarter of 2010. In other words, any further near-term decline in output is likely to be recouped in late 2009 and / or early 2010. By contrast, the latest Inflation Report fan chart appears to imply only a 40% chance of positive annual growth in the first quarter of 2010 (precise figures will be available tomorrow).

The indicator's output can also be expressed as a mean forecast for annual GDP growth three quarters ahead. Based on the latest input values, the forecast for the first quarter of 2010 is 0.7%. The Treasury's projection of 1.25% GDP growth for 2010 as a whole therefore appears reasonable, barring an economic relapse later next year.

The fall in the recession probability estimate has been driven by declines in short-term interest rates and the effective exchange rate and – more recently – firmer real money growth, a rally in share prices and narrower credit spreads. With little scope for short rates to move lower, however, and sterling finding a floor recently, further improvement is likely to depend on stronger monetary trends.

It would be surprising if the expanded £125 billion QE programme – equivalent to 8% of the adjusted M4 money supply – failed to produce a monetary pick-up. Provisional April broad money figures published on Thursday will provide more information on the impact of recent official gilt purchases.