The Bank of England’s latest inflationary report hit the headlines yesterday, and this morning. What a gloomy picture the report painted. Mervyn King, the bank’s governor, has now said we are probably in recession.
It is tempting to ask, of course, why should we believe the findings of the report, after the bank so woefully failed to predict the crisis we are now seeing?
Come to think of it, there is still much in this report to suggest the Bank of England still isn’t up to speed.
There are only two possible explanations. Either the bank still hasn’t got it, or it is trying to talk up sterling.
“This is a difficult and unprecedented time, but we will come through this,” said Meryyn King yesterday. Sure, the Bank expects GDP to contract 1.5 per cent throughout the course of 2009, but it then expects to see 1.7 per cent growth in 2010, and 3 per cent growth in 2011.
And yet, when the last report was published, the Bank of England said it expected growth to be flat next year. In May it was merely talking about a sharp slowdown in growth.
As for inflation, it completely failed to get the call right.
In May, the bank said: “The challenge facing the Monetary Policy Committee is to balance two conflicting risks to inflation in the medium term. On the downside, a sharper than expected slowing in activity could pull inflation below the target. On the upside, inflation, after a significant period above target, could have a greater tendency to persist… the balance of these risks around the central projection is to the upside.”
Yet, at about the same time, a series of articles appeared here warning that deflation, not inflation, was the real worry. For much of this year, plenty of publications, including this one, warned that the risk of recession was much higher than we were being told.
The writing had been on the wall for months, the Bank of England failed to call it.
Now it is looking at a 15 per cent chance of negative inflation next year.
It does seem that this probability is far too low. If inflation does not turn negative by the end of next year, or the beginning of 2010, it will be a big surprise – and remember, you read it here first.
The one possible thing that could stop deflation is the fate of sterling. If the pound should fall much further, then import costs will rise so high that the effect of falling global prices might not be felt by the UK.
In this vein, the Bank of England warned that you can’t have low interest rates, and indefinite fiscal stimulus. Mr King said: “In these extraordinary circumstances, it would be perfectly reasonable to see some use of fiscal stimulus, provided two conditions are met. One, that it’s temporary. Secondly, that it would be clear there was a medium-term plan to bring tax and spending into balance.” The implication was left hanging. If neither of these conditions are met, rates will not fall so far.
Ultimately, though, the UK has to learn to pay for its spending, and it can do this by exporting more.
Too many economists want to see a return to the good times, for it to be like 2006 and 2007 all over again. This can never happen. The UK can only recover in a sustainable way via an export-led expansion. In the past, a falling pound was often accompanied by rising inflation – which had the effect of cancelling out the benefit of cheaper sterling. It seems unlikely we will see a repeat of that.
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