Sunday, August 07, 2022
Looking for a light at the end of a very dark tunnel
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

There was a time when “not for those of a nervous disposition” was the standard warning on particularly scary films, often starring the late Vincent Price, or even books. It could easily have been applied to the Bank of England’s latest projections, or maybe Edvard Munch’s The Scream. The Bank’s latest monetary policy report, published alongside its decision to raise Bank Rate from 1.25 to 1.75 per cent on Thursday, was a horror story.

The rate rise, the biggest in 25 years of independence, was expected, and anticipated here last week. The new news was the Bank’s deep gloom about the economy, with inflation peaking at more than 13 per cent later this year and still being at 9.5 per cent in roughly a year’s time, the economy entering a five-quarter recession at the end of this year and the unemployment rate rising from 3.8 to 6.3 per cent over the next three years.

This would be as the Bank made clear, a Putin recession, brought about by a near-doubling of wholesale gas prices since May, because of Russia’s restriction of gas supplies to Europe, with the threat of more to come.

A recession is not inevitable, a I discussed here last week, and the Bank has different scenarios depending on what happens to energy prices. But another big price shock is inevitable this autumn.

The Bank does not do gloom on this scale lightly. Out of interest I looked back to what it was saying in its quarterly reports in 2008. In May and August, it expected a slowdown, but not a recession. Only in November, after the collapse of Lehman Brothers and the bailout of much of the UK banking system, did it recognise the inevitable.

As the Bank said on Thursday, things could turn out either worse or better than it now expects. Though it does not use the phrase, “slumpflation” has become a better description of the outlook it expects than stagflation. Though he would not be drawn on the Tory leadership contest, the noises off from the Truss campaign about Bank independence do not make the job of Andrew Bailey, the governor, any easier. More on that soon.

It would be very easy at this stage to get overwhelmed by the gloom. But, as plausible as the Bank’s forecasts of very high inflation later this year and well into next, so are its predictions that in a couple of years inflation will be at or below its 2 per cent target and in three years below 1 pe cent and skirting close to deflationary territory; falling prices. This was why one member of the Bank’s monetary policy committee (MPC), Silvana Tenreyro, favoured only a quarter-point rise last week.

I do not diminish the problems that we now face, particularly low-income households and energy-intensive firms. Each day brings new horrors when it comes to the likely path of energy bills in the autumn, and the cost-of-living crisis is bearing down on the economy. The decision to allow the holidaying Boris Johnson to continue as prime minister until his successor is chosen has created a vacuum in government at a time of intense domestic pressure on the economy and worrying international tensions.

But, looking as I always do for reasons to be cheerful, one thing that the Bank has been worried about is inflation expectations. But, despite the surge in inflation to 9.4 per cent (so far) and 11.8 per cent retail price inflation, such expectations appear to be, in the jargon, “well anchored”.

Bank of America’s “Consumer Whisperer” survey suggest that, while people expect higher inflation over the next year, their expectations for inflation over the next five years have come down from the peak of a few months ago and are not much different from normal. Other surveys show a similar picture.

The Bank of America survey also suggests a small rise in consumer confidence, while the longer-running GfK measures suggests that it has stabilised, in each case at very low levels. This may reflect government cost-of-living support kicking in, or that, having weathered the April energy price and tax increase storm, people think that it could have been worse.

Business confidence also edged up slightly last month, according to the Institute of Directors, though its chief economist, Kitty Ussher, notes that “risks in the macroeconomy continued to drive the behaviour of business leaders in July, with concerns around inflation, our relationship with the EU and political instability causing investment intentions increasingly to be put on hold.”

We are not, either, seeing a wage-price spiral. Average earnings growth of 4.3 per cent for regular pay looks like a model of restraint. And, while 6.2 per cent growth in total pay is too high for the Bank’s comfort, some of that reflects that fact that some businesses are offering their own cost-of-living support in the form of one-off bonuses, which are not being embodied in basic pay. The Bank’s agents expect pay increases to average 6 per cent over the next year.

All this could, of course, go badly wrong in the autumn, when the energy price shock enters a new phase. Confidence could tumble, inflation expectations rise and workers demand much more compensation for surging costs. Things will undoubtedly become more difficult and require additional government support, which is not built into the Bank’s recession forecast. It is not, though, as if any of this should come as a surprise, in a way that the spring surge in inflation caught many out.

It is in the autumn that, in the absence of further support, the Bank expects the economy to embark on a recession similar in scale to that of the early 1990s, with a drop in gross domestic product of more than 2 per cent in its baseline projection and the hangover continuing into 2024, when annual growth in the economy is expected to be negative. That early 1990s’ recession was relatively mild in GDP terms but devastating for the housing market, though interest rates were much higher then than now, reaching 15 per cent just before the recession.

There are plenty of reasons to fear the worst, though nothing like that for interest rates. Amid the gloom, we can only hope for the best. The prospect of a significant future fall in inflation is a reason to hope.