If you read today’s Bank of England inflation report, you will notice some welcome changes. More will follow on this blog about the improvements in BoE transparency. In the meantime, the five things you need to know about the bank’s economic outlook are:
1. The Monetary Policy Committee has become more optimistic
For the first time since 2007, there has been a broad improvement in the economic outlook, according to the BoE. Growth forecasts are up while inflation forecasts are a bit down, indicating a better trade-off between the two. The following chart shows the progression of forecasts since 2007, with the persistent deepening pessimism moderating this quarter.
Interestingly, the biggest change to the bank’s forecast of growth relates to the past, not the future. This raises the 2013 central growth forecast from 0.9 per cent to 1.2 per cent, an improvement yet to feature in the average of independent forecasters figures.
At the end of 2014, it now thinks it is most likely that output will be just shy of 1 per cent higher than it thought probable in February. Most of that upward revision comes upward revisions to the level of GDP in the actual data released over the past quarter, not a change of view in the BoE over the likelihood of GDP data being revised higher.
2. The outlook is still far from strong
The bank correctly and repeatedly tells people not to get hung up on small changes in the central forecast. As the chart shows, even with a modest dose of optimism, the deviation of real output from the pre-crisis trend is still enormous and the slope of the forecast line is also shallower than before 2007.
The big picture is therefore of weaker average growth as far into the future as the BoE can see – roughly of the order of 2.2 per cent annual growth, not 2.8 per cent annual growth.
3. Matters abroad matter
The inflation report blames export weakness for poor growth in 2012. “Domestic demand increased moderately during 2012, but this was largely offset by a pronounced fall in exports,” it says in the report’s second sentence.
Sir Mervyn King also highlighted his favourite topic that a sustainable global recovery is impossible without surplus countries (read China and Germany) consuming more to allow deficit countries to generate more growth through net trade and investment.
“There are limits to what can be achieved by general monetary stimulus – in any form. If we are to see a return to sustained growth, not only the UK economy, but the world economy as a whole, must find a way to a new equilibrium in which there is a rebalancing of world demand. Those are not challenges that can be resolved by monetary policy alone, nor can they be resolved by any one country alone,”
the governor said in opening remarks.
4. The inflation report has improved
For those who like source material, the inflation report is has been revamped and the changes make it better. The BoE has released its detailed forecast on the day, allowed more discussion of the changes in its forecasts and included a very useful table of key forecasting judgments (Table 5.A on page 42).
These changes make it possible to get a much better sense of the MPC’s thinking, particularly on the big unknowns. The forecasts are based on the eurozone beginning to recover later in 2013, the hangover from the financial crisis continuing to moderate, the growth in demand leading to no new supply pressures and an end to the puzzle of terrible productivity, allowing inflation to fall back towards the end of the three-year forecasting horizon.
The bank could go further and release its full forecasts which would be extremely useful not for understanding thinking, but for helping everyone think about the causes of the inevitable forecasting errors. Publishing this detail has been the saving grace of the Office for Budget Responsibility as it has enabled it to explain cogently why its headline forecasts have been horribly wrong.
5. Sir Mervyn King takes his leave of the inflation report
The governor said it was his 82nd and last inflation report press conference. He has presented them all as chief economist, deputy governor and governor of the bank. While refusing to dwell on questions about his record and the past, he did talk about how he felt about the economy under his watch.
“It is pretty obvious that the global banking crisis led to a pretty sharp downturn. I think we all know that. And that was four or five years ago. The question is, looking ahead, can we manage to get out of this. I think there are two or three things that could be done, most of which I think we in the UK have done. The big unresolved issue is the international one.
So, domestically what we need to do is to make sure that in the banking system we never go back to the degree of leverage we had prior to the crisis, and I think the actions of the financial policy committee, the legislation to introduce a resolution scheme, the Vickers proposals are on the table, combined with the new Basel approach all go in that direction. I think we are pretty close, but we are not quite there yet to getting a banking system with which people in the future will be able to be proud and not worry as we have been worried.
Secondly, the government has put in place a medium term fiscal consolidation path – there is plenty of room to discuss the precise parameters of it – but that we need a medium term path of fiscal consolidation seems to be agreed by everyone.
What we can’t do, clearly, is ensure that the rest of the world grows at its normal historical rate. If it were, we would be in pretty good shape already by now given the depreciation of sterling which has helped to boost external demand by offsetting the contractionary effects of fiscal consolidation.
So, by and large I think we are on track. What matters is when you have a crisis actually producing ideas which deal with the causes to ensure that we don’t go back to the situation we were in. And I feel very proud we managed to do that.”