Sometimes central bankers talk in code. Words like continue, contained and moderate, seem to come loaded with enough hints and insinuation to keep the media talking for weeks. Alan Greenspan used to go to the extreme, and was downright cryptic. In fact, he once famously said: “If I seem unduly clear to you, you must have misunderstood what I said.” But yesterday it wasn’t like that. Mervyn King, governor of the Bank of England set the tone with his opening sentence in yesterday’s inflation report published by the Bank.
“It may still – just – be summer,” he said, “but there is a feeling of chill in the economic air.”
Okay, there was one word Mr King, in his moment of candour, just wouldn’t use. He just could not bring himself to utter the R word. But, he made it quite clear this nine-letter word, that policy makers dread so much, was on his mind.
When the Bank of England makes its projections it presents a range of possible outcomes, attaching probability to each outcome, and it presents this information as a fan chart. The fan chart deviates around a central projection. And the central projection is this: economic growth will slow to around zero by the end of this year. For the next year or so, the Bank expects growth to be “broadly flat.”
In other words, the Bank of England is now saying the economy is just a whisker away from recession – if it has overestimated growth by the tiniest amount, then it’s recession.
Bear in mind, projections for growth have been steadily falling. When the Bank published its previous inflationary report, three months ago, it was expecting growth to bottom out at around 1 per cent. Three months ago a single quarter of negative growth did show up on its fan graph, but only just, and a very slim level of probability was attached to this outcome. Now it is suggesting there is a possibility of a recession lasting over a year.
But while the Bank of E gave its strongest warning yet on the dangers of recession, it was altogether more sanguine on the inflation front.
Sure, it expects inflation to rise some more. Its fan chart even allowed for the possibility of inflation hitting 6 per cent.
Furthermore, it expects inflationary pressures to mount for another year or so, but, then, it thinks things will go into sharp reversal. It expects inflation to be lower than 2 per cent within two years.
All in all, then, what with the grim warnings on growth, and the more positive attitude to inflation, analysts have reviewed their predictions on the future course of interest rates. Now, the expectation is for rates to fall later this year. Until yesterday, most had expected one more hike in rates.
The trouble though with these Bank of England reports, as indeed with just about all forecasts, is that they tend to be behind the curve. They base their projections on data, but the data is flawed. Instinct, even common sense, does not come into it.
Sure, the Bank of England, just like every other forecaster, has downgraded its projections – but they are only really being downgraded to what we all suspected all along.
Some have accused the media of talking us into a recession. This is not true. The media are not hamstrung by flawed data, and for that reason their warnings have, quite frankly, had more credibility than the gentle and periodic downgrades we have been seeing from those who are supposed to be in the know.
In its latest fan chart, the Bank of England made no allowances for the possibility of negative inflation over the next couple of years.
But, consider this. Latest data on the job front, also out yesterday, revealed that wages rose by just 3.4 per cent during the April–June quarter of last year. That was with bonuses; without bonuses, average earnings were up 3.7 per cent.
The fact is, while inflation has been rising, average earnings have been falling; they have only been falling slightly, it is true – but it is surely highly significant that they are going in the opposite direction to inflation.
As for unemployment, this rose by 0.2 percentage points, or by 60,000. However, the number of people in employment did rise by 20,000. But the growth in employment seems to be coming to a standstill. Expect this to go into reverse soon.
As we have argued here many times, this time around there are good reasons to believe fears on job security could lead to much more modest wage rises in the year ahead.
It seems more likely the Bank of England has understated growth and inflation in the short-term, and overstated inflation in the medium-term.
Projected growth Bank of England inflation report: August
Projected growth Bank of England inflation report: May
Comments
Trackbacks