The November Inflation Report published today is very dovish and will boost expectations of a fall in Bank rate to below 2% by early 2009. In his press conference comments, Mr. King also appeared to welcome substantial fiscal loosening while playing down concerns about the plunge in the exchange rate. However, the commitment to maximum policy stimulus sits oddly with the Report’s forecast of a relatively shallow and short recession. Markets may begin to worry about a loss of financial discipline.

Key points:

• The mean CPI inflation forecast in two years’ time based on an unchanged 3% Bank rate is just 0.9%, by far the largest deviation from target in the MPC’s history – see chart. This compares with an above-target forecast of 2.2% in August.

• The associated fan chart implies a 20% plus chance of CPI inflation being below zero in two years’ time.

• While it is difficult to infer precise figures from the chart, the growth forecast based on unchanged rates is consistent with GDP declining by about 0.5% per quarter between Q4 2008 and Q2 2009, stabilising in Q3 and then recovering by 0.5% per quarter over the following year. This would imply a peak-to-trough decline in GDP of about 2%, with annual average changes of -1.3% in 2009 and +1.7% in 2010.

• As discussed in a previous note, an average path derived from the last three recessions would entail a peak-to-trough fall in GDP of 2.3% with a recovery delayed until Q2 2010. This path would imply an annual fall of 1.7% in 2009 with growth of just 0.4% in 2010.

• Mr. King also stated that an updated growth projection would be less gloomy because of prospective fiscal loosening and recent sterling weakness.

• The large and sustained inflation undershoot is questionable against the background of a moderate recession and a substantial fall in the exchange rate. Either the MPC’s GDP forecasts are insufficiently downbeat or inflation is likely to revive sooner than the Report projects.