Wednesday, 12 November 2008

fan chart fantasies

It is hard keeping up with the violent gyrations of the Bank of England economic forecasts. So far this year, the bank have produced three; each one radically different from the next.

The spring forecast offered a highly complacent perspective for the UK. Inflation and output risks were balanced. Despite the credit crunch, inflation would return to target, while the risks to output were contained.

With the August forecast, the balancing act was over. The UK had fallen off decisively on the inflation side. The CPI rate was about to surge beyond 5 percent and would only return to target by the middle of 2010. While the growth prospects were dimming, there was no talk of a recession.

Today's forecast (see above) lurches in another direction. According to the Bank, inflation is no longer the problem; the UK is now in recession. Moreover, the central forecast is for 6 quarters of negative growth, with the whole of 2009 being written off as a recessionary year.

Looking back at the August forecast, the bank made the right call on inflation; it did surge to a 16 year high, reaching 5.2 percent in September. As for new inflation forecast, the bank now expect a more rapid decline in prices. The CPI inflation rate will hit the 2 percent target sometime next year, a full 12 months earlier than the expectation in the August inflation report.

So what is it going to be? Inflation or deflation? Which is the bigger problem; recession or rising prices?

So far, so bad. Despite the so called radical policy gestures, the Bank of England has contrived to produce the worst of all worlds. The UK economy managed to hit a 16 year high in inflation, and now it is likely to fall into the deepest recession in a generation. So much for the MPC's balancing act.

However, the inflation report goes to great lengths to explain that none of this is the fault of monetary policy. It is all due to the credit crunch and the global financial crisis. Today's macroeconomic mess had absolutely nothing to do with the bubble economics that Brown, the BoE and the FSA practiced for the last 12 years upon the luckless UK economy.

So what is my take all this twisting and turning? The BoE inflation forecast depends heavily on a continued decline in oil prices and a collapse of the UK economy into a very nasty recession. If their inflation forecast proves to be correct then it confirms that the recent rate cuts were for Fleet Street; the 150 basis point cut made great headlines; but will have a negligible impact on the real economy.

However, the rate cut will undermine sterling; an issue that the Bank of England have dangerously underplayed in today's inflation report. If the exchange rate continues to slide, import prices will continue to rise, and then the BoE's rapid decline in inflation may look more like wishful thinking.

The growth forecast is shocking but recent real sector developments offer little confort. Unemployment is up, the 3rd quarter GDP number was negative, and the country as whole is smothered in a cloud of depression.

Personally, I doubt that inflation will come down quite as quickly as the bank thinks, but I fear that they might be spot on with their growth forecasts.


Anonymous said...

today's report did a number on sterling. It is on the slide.

Anonymous said...


Thanks for another interesting post.

Do you have an inflation graph like the output growth one, showing how the BoE's predictions compare with ONS actual CPI figures?

aSteve said...

Reuters today has oil at $53 - whereas a few months ago it was $147... and you're still worrying about inflation?

The inflation charts in this report, you might note, are somewhat similar to the one I sketched and posted here before inflation peaked... I stand with my past judgement - and while I think these fan charts are more credible than those in the past, I think they're too optimistic... I expect to see inflation dramatically under-shoot the 2% target... and I don't see what will bring it back for several years... except, possibly, an extremely severe devaluation of Sterling.

Nick von Mises said...

"It is all due to the credit crunch and the global financial crisis."

Don't tell me, the BoE's next sentence is "...which started in America"!

I think you're ahead of the curve compared to all the idiot analysts and chief economists but you really need to put this inflation thing to rest. While I grant you had reason to believe in it when commodities were bubbling, China was overheating, and the CPI was spiking, there really isn't anything left to base it on except the rear view mirror.

Anonymous said...

Alice - they want Sterling to sink. If you look at GBP against the USD going back to 1970 you'll see the pound went to $1.05 in 1985. We could easily see parity with the Yen, Euro and Dollar. Inflation won't be too much of a problem because most people will be skint. Commodities will fall further as the Global Depression gathers steam.

They are desperate so rate cuts and a falling pound are their tools.

I think this will be a horrible depression with unemployment 4m+. Over the coming years we could lose all the GDP growth of the Fake 'brown' Decade.

House prices will halve as the buy-to-letters get skinned.

Anonymous said...

The pound will hit dollar par by xmas: mark my words. As for my plans? I am going into porn big time. All those UK honeys will want to keep their slutty, fashion-buying, binge-drinking, partying ways, and they won't be able to do that with a day job. It is time to get busy girls, and earn your booty by working your booty.

Anonymous said...

Thanks for the amazing graphs Alice.
I do wonder why you always portray rising prices as being inflation when inflation is usually a measurement of money against available goods.
I think personally that imported goods are becoming more expensive because we are dependant on food and energy imports, and our main trading partner, the EU, is not dependant on anything produced in the UK. However, even that truism will be swept away in the deflationary recession that we are only starting to feel now.
I am 38 years old. I used to worry about getting an affordable house. Now I worry that the UK won't recover during my working life. I believe that we are still only glimpsing how bad things will be. People talk of a recession as though only jobs will be lost. There is a housing crisis now which will go critical, crime will certainly rise, there will be more pressure on already sub-standard schools, racial tensions will worsen and the elderly will face living in poverty.
I really worry about the future personally. I no longer worry about the UK housing ladder, I worry about a catastrophe which we might see even as soon as April.
I really feel saddened by the whole thing because its so pointless.

Nick von Mises said...

Anon 12:54.

Questionable life choices aside, I think you should start with Iceland.

Anonymous said...

There is already a clique of nasty skinheads who have taken a spot in the local pub around the corner from my place. I see them more and more walking their dogs. They don't look like friendly, nice, New Labour-loving chaps. I don't feel comfortable with the fact they are hanging around more.

Anonymous said...

They don't look like nice New Labour-loving chaps !!!!!!!!!!!!!
At least you only get punched once in the face. Under New Labour you have a decade of poverty.

Anonymous said...

Maybe slightly off topic (apologies). But I'd be grateful if someone could explain how painful a short or long period of deflation would be for heavily indebted consumers - I'm thinking mainly credit card debts/overdrafts etc. And yep, I'm thinking of my idiotic self in getting into such a mess.

Thanks Alice, as ever, for an insightful, if ever disturbing, blog.

RenterGirl said...

So: how are we doing getting that Public Inquiry about the Bank Of England's behaviour on regulation, and forecasting, then? Nothing come of it? I'm shocked and amazed to hear it...

Markbaldy said...

With reference anonymous's comment "I am 38 years old. I used to worry about getting an affordable house. Now I worry that the UK won't recover during my working life."
I feel the same - I am a bit older and seriously considering a move out of the UK.
I was waiting for house prices to halve (as they will over the next 2 or 3 years), but what then ? What about work prospects, having enough money for a comfortable retirement ?
It is increasingly expensive to live in the UK, crap quality of life, rubbish weather and the way the country has gone socially and politically is beyond sad.
When Brown's desperate recovery plan sinks into the mire, the country will be
broke, crime will be at epidemic levels and a lot of people will be living in total poverty with little chance of escape from that.
Don't blame the US sub prime market Gordon - history will show that YOU were responsible for the mess that could easily have been avoided by truly being prudent.

electro-kevin said...

Anon at 22.41 said

"There is already a clique of nasty skinheads who have taken a spot in the local pub around the corner from my place. I see them more and more walking their dogs."

I've noticed more of this sort of thing too - particularly nasty tattoos up necks and on faces, an equally nasty pitbull on an equally nasty chain ...

These are most definitely Nu Lab lovers.

(Picture of me on my blog for you to throw darts at if you want to, Alice. Try not to hit Daisy though. She's totally innocent.)

sobers said...

Does the 'recovery' predicted in the BoE growth fan seem rather sharp to you? I can't see the economy making such a sudden lurch upwards in the middle of 2009. What could cause this? In the early 90s we had the stimulus of leaving the ERM, with lower rates and lower pound. While the same is likely now (ie rates to zero, pound to possible parity vs $)the amount of debt is much higher now. I can't see consumption suddenly making comeback, and we don't have the export industries to take advantage of the lower £ and rates. I forsee several years of bumping along around zero to 1% growth.

Mark Wadsworth said...

This whole inflation vs. deflation debate is futile. We know that the UK has lived beyond its means for several years now, and half of us are severely in debt (the other half are rolling in cash, relatively speaking).

Ergo, people will rein in spending on 'luxuries' (as defined) just in case they lose their jobs or their income falls. Seeing as half of GDP goes on luxuries (i.e. not food, rent, utilities, cloths for kids) that's one heck of a downturn.

From there on in, it's a perfect storm.

monoi said...

Interest rates are of little value to the currency.

If they were, explain how the $ has richen 25% vs the £ with lower rates.

Anonymous said...


If you look at the growth fan chart, the bank have continually been too optimistic about growth as the ONS actual growth line is always to the underside of their central projection.
Looking at the gradient of the last quarters 'supposed' 0.5 GDP contraction, the 'negative growth' has accelerated.

I therefore find it extremely hard to believe that the recovery will happen as quick as they are predicting from their V projection.

I think inflation will fall steeply, but the economy is not going to recover that quickly. Unless of course we borrow our way out of it, not implausible. Maybe the BofE know something we dont, like a 2% cut in income tax!

Hi markbaldy, this is budgie from work!


Nick von Mises said...

"If they were, explain how the $ has richen 25% vs the £ with lower rates."

That's easy. USD is base currency and most developed economy. In a crisis all the risk capital returns home which means buying of dollars and selling of other currencies.

Yen strengthened for similar reasons, plus the carry trade unwind.

GBP will eventually benefit from this relative to everything except USD, JPY and possible EUR. Remember that despite 11 years of Gordon the UK is still a senior economy surpassed only by the US, Japan, Germany and possibly France.

It was only four months ago that the US retail investors were having precisely the same currency panic as the UK now.

Anonymous said...

I have already moved to majority overseas clients. And what can I say? They are nicer people, treat me better, and when I go visit them in places like Geneva, well the food is fab. Oh, and the women? Just got a girlfriend in Argentina and she is wild! Leave the UK my friends. Have a life!