The monetarist rule is that the (real) money supply leads economic activity by between six months and a year. This rule has worked well in recent years: G7 real narrow money contracted in late 2007 before the recession but surged in late 2008 ahead of the economic recovery from spring 2009.

G7 real money expansion fell back temporarily around the end of 2009 but rebounded to a peak last summer. This pick-up has been reflected in a strong global economy in early 2011. Real money, however, has continued to slow in recent months. Based on the monetarist rule, therefore, global growth should lose momentum from the spring.

Other evidence is starting to confirm this scenario. The chart shows the six-month growth rate of combined industrial output in the G7 and emerging "E7" economies together with a forecasting indicator based on the OECD's country leading indices, which incorporate a wide range of economic and financial inputs. The indicator usually leads turning points in output expansion by between three and seven months and has fallen since December, suggesting a growth peak between March and July.

In contrast to late 2007, real money expansion and the leading indicator remain positive – they are not signalling major economic weakness, let alone the dreaded "double dip". Directional changes in the indicator, however, tend to be sustained so a further decline is likely over coming months, in turn implying that the economic slowdown will extend into late 2011.

Importantly, the fall in G7 real money growth has been due to rising inflation rather than a slowdown in nominal monetary expansion. It does not, in other words, reflect any tightening of policy by the G7 central banks. Without policy restraint, inflationary pressures are likely to remain elevated. The outlook, therefore, is for slower economic growth but limited relief on inflation – an unappealing "stagflationary" prospect for markets.