Sterling's effective rate index reached a nine-month high on 5 August, the day before the Bank of England's announcement of a £50 billion expansion of its quantitative easing programme. It had fallen by 6.9% by last night's close, with a further move lower this morning. The timing is unlikely to be coincidental. The Bank's gilt-buying may be creating excess liquidity in the economy, helping to explain surging equity and prime property prices as well as the fall in the pound.

The suggestion that monetary conditions are over-expansionary may appear strange given recent sluggish growth in the Bank's favoured broad money measure – 5% annualised between January and July. However, the velocity of circulation of money is probably rising in response to record low interest rates and reviving risk appetite so the current rate of expansion may be more than sufficient to support an economic recovery, implying an excess available to push up asset values, including the sterling price of foreign currencies.

A recovery in velocity is suggested by a recent shift of funds out of savings accounts into cash and accounts used for transaction purposes: "non-interest-bearing M1" – comprising cash and interest-free current accounts – rose by 46% annualised between January and July. Strong retail buying of unit trusts and OEICs is also consistent with a reduced demand to hold money – see earlier post.

Though the figures relate to the second quarter, today's National Statistics release on institutional investment flows provides evidence that some of the liquidity created by the Bank's gilt-buying is flowing overseas. Insurance companies, pension funds and trusts bought £13 billion of foreign shares and bonds last quarter – the highest since the third quarter of 2007.

With the economy recovering and inflation continuing to overshoot the Bank's forecasts by an embarrassingly large margin, the case for a further extension of QE was already looking weak. Sterling's slump adds to the reasons for caution and – if sustained – could lead markets to bring forward expectations for monetary tightening.