Satellite retrievals of environmental parameters for October 1993 were used to validate the Canadian Meteorological Center (CMC) analysis/forecast system and an improved version of the forecast model (including a prognostic equation for cloud water). In part 1 <Deblonde and Wagneur, this issure>, SSM/I (special sensor microwave imager) retrievals using different algorithms were intercompared for each environmental parameter column integrated water vapor (IWV), near-surface oceanic wind speed (SWS), liquid water path (LWP) and surface rain rate (SRR). Here a subset of the SSM/I retrieval algorithms that performed best and other observation data sets are used to evaluate the hydrological cycle of the analysis/forecast system on a monthly timescale. Over the global oceans the agreement between analyzed IWV, forecasted IWV, and SSM/I retrievals was quite good (R~0.96). However, where Humsat (GOES) retrieved water vapor profiles were assimilated, significant biases were observed in large areas (up to ~15 kgm-2). Significant differences were found between analyzed SWS and SSM/I-retrieved SWS. In the tropics, zonally averaged analyzed SWS was underestimated by up to 1.4 ms-1 and in the southern hemisphere midlatitude differences of ~1 ms-1 were found. Forecasted cloud fraction from the improved model was compared with that observed using the Humsat retrieval system. Over the open oceans, modeled cloud fraction was overestimated by 8%, suggesting that cloud formation was too active. By comparing SSM/I LWP retrievals with those forecasted it was possible to identify mispositioning of cloud systems that were associated with noted biases in the humidity analysis. It was also shown that the choice of function to obtain the liquid phase component of the modeled cloud water modified considerably the magnitude of the monthly mean LWP, particularly in the midlatitudes. The differences in patterns between precipitation short-range forecasts (accumulated over a month) obtained with the operational and improved forecast models were considerably smaller than the differences between each of these forecasted fields and SSM/I retrievals or long-term climatologies. ¿ 1997 American Geophysical Union