The latest Inflation Report is downbeat and will douse recent hopes that the recession is nearing an end. The MPC is arguably too gloomy, particularly about the balance of risks to activity, and may be underestimating the potential boost to the economy from its expanded QE operation.
Key points:
- The central-case GDP forecast is significantly weaker than in February – see chart. This reflects both a lower-than-expected first-quarter outcome and a slower recovery in 2010-11, with the MPC more concerned about credit supply constraints than in February (odd given improvements in the last credit conditions survey).
- The central-case path – estimated from eyeballing the fan chart – implies further falls in GDP in the second and third quarters followed by marginal expansion in the fourth quarter and first quarter of 2010. Trend-like growth resumes in the second quarter of next year. GDP returns to its peak level only in early 2012 – a year later than in February.
- The central-case path is notably weaker than the Treasury’s Budget forecast. The fan chart implies annual average GDP changes of an estimated -3.9% this year, +1.0% in 2010 and +2.6% in 2011 versus the Treasury’s -3.5%, +1.25% and +3.5% respectively.
- Cleverly, however, the MPC has concealed the extent of its difference with the Chancellor by expressing its gloom partly in a negative risk skew to the central-case forecast. The mean projection, taking into account this skew, appears to be for GDP growth of only 0-0.25% in 2010 and 1.5-1.75% in 2011 – far below Mr. Darling’s assumptions.
- The MPC underestimated the inflationary impact of sterling’s plunge and has revised up its near-term CPI projections. The change, however, is modest: inflation averages an estimated 1.6% in 2009 in the central case versus 1.4% in February. Currency effects are judged to be offset by a wider margin of spare capacity and a larger fall in household energy tariffs than assumed in February.
- Longer-term inflation projections have also been revised higher but remain below 2% as far as the eye can see. The central-case forecast for the first quarter of 2012 is an estimated 1.6% versus 1.1% in February. The MPC may be lowballing the numbers in an effort to keep inflation expectations anchored against a backdrop of QE and fiscal profligacy.
