Like police officers at the scene of a nasty car crash, the Bank of England's top team appears very keen to keep prying eyes away from its inflation forecasts. "Move along, sir, nothing to see here!"
Given the speculation in the market that preceded it, yesterday's publication of the quarterly inflation forecasts was an anti-climax.
The prospects for inflation were revised up in the short-term and down in the medium-term but are seen as rising towards the end of the two-year forecast horizon, whereas in February the Bank saw it falling.
Growth was revised down near-term and up further out, but the difference between the February and May forecasts was negligible.
Mervyn King, the deputy governor who takes over the top job in July, played a straight bat to every googly the journalists at the news briefing bowled at him.
Yes, sterling's depreciation was a very significant event but, no, the inflationary impact would not be as great as in the past and there was no concern over financial stability. Yes, house-price inflation will collapse to zero twice as fast as the Bank thought three months ago but, no, it was in fact quite welcome.
Yes, deflation is currently a huge concern for both the United States and the eurozone but, no, it is not a concern here because of the insulation that a falling pound provides.
Yes, there is a divergence between the Treasury's 3 to 3.5 per cent growth forecast and the Bank's 2.5 per cent but it should not be exaggerated.
Overall then, the message was clear – sterling's fall will push up growth and inflation enough to prevent another rate cut but probably not enough to prompt any thoughts about a rate hike. The report said the risks to both growth and inflation were "broadly balanced". Rates on hold pro tem, in other words.
Overall, this was much less worried about the threat of inflation than the financial markets had expected and they reacted immediately by closing down their bets on a rate hike. But the message of the inflation report has left many analysts in the City of London either bemused or confused.
Robert Barrie, UK economist at CSFB, said the Bank did not see the exchange rate as important as the financial markets did. "The exchange rate has fallen an awful lot but the growth and inflation forecasts did not change too much," he said. "On the scenario of a gradual recovery and not much change in the exchange rate then I think the next move in rates would be up – although not imminently."
However, according to Mr King the relationship between a move in exchange rates and inflation and growth is anything but straightforward. "The idea of a trade-off or a rule of thumb or a monetary conditions index does not make much sense," he said. "Banks that have adopted a monetary conditions index have had to abandon it."
The Bank has for several years tried to steer analysts away from rules of thumb such as a 4 per cent exchange rate move translating into a 1 per cent rise in inflation.
Mr Barrie disagreed. "I think the exchange rate is very important and very straightforward," he said. "The mechanical ways of thinking about it are exactly the right way."
However, in a key part of the report, the Bank said it did not believe the impact on inflation would be as dramatic as in the past. It said the so-called second-round effects – responses by consumers and wage negotiators to price rises – would be reduced by expectations that inflation will stay close to the Government's 2.5 per cent target.
Colin Warren, an analyst at GFC Economics, agreed, saying retailers and producers had little room to raise prices in the face of weak demand. "At this stage, the upside inflation risks appear slight in comparison to the downside threat posed by the unwinding of the consumer boom," he said.
Away from the economic debate, the Bank made it quite clear the fact or the speed of the depreciation in the pound did not overly concern the Bank. "I don't think the Monetary Policy Committee is especially worried about the speed at which sterling has fallen," Mr King said, rejecting suggestions it could cause financial instability. The Bank said it was important first to assess what the underlying factors were that caused the slump in the pound. Mr King said the fall in sterling – which tumbled by a record 5 per cent between the two inflation reports – followed signs of economic weakness in the first months of the year.
In other words, the inflationary consequences of the fall in the pound had to be balanced against the disinflationary impact from much slower growth than the Bank had forecast three months ago.
In fact, some economists believed that, if anything, the Bank had been too optimistic in its growth forecasts, which was mainly attributed to a boost to the UK's export sector.
David Page, UK economist at Investec, said the Bank had been explicit in forecasting a sharp fall in consumer spending and in house-price inflation, while real income growth would be crimped by rises in council tax and national insurance contributions. "The Bank's current forecasts embody a sharp acceleration in the second half of this year with quarterly growth of around 0.8 per cent in both quarters, which still looks too optimistic for us," he said. "Without clear signs of a revival in global demand over coming months, there is nothing in the inflation report to stop the MPC cutting rates one more time."
The growth forecasts presented Mr King and the Bank with a thorny problem – how to revise up growth without appearing to kowtow to the Treasury. In the end it raised its forecasts for 2004 to 2.5 per cent from 2 per cent but still short of the Chancellor's range of 3 to 3.5 per cent.
Mr King insisted there was "hardly a dramatic difference" between the Bank's figure and the lower forecast of 3.0 per cent the Treasury uses for its public-finance forecasts. "Try to put things in a reasonable perspective," the deputy governor said. It gave him an excuse to show that he will defend the independence of the Bank.
"It's best for the Treasury to make its forecasts and the MPC to make its own judgement," he said. "We are not concerned as to whether they have the same or different figures. The probability of either of our central projections being right is close to zero."
Charles Bean, the Bank's chief economist, said the Treasury had assumed a faster growth rate for productivity and growth in the labour force.
The Bank traditionally says its forecasts are subject to risks and uncertainties and yesterday was no exception. One of the key shifts in the forecast was the decision to bring forward the timeframe for an abrupt slowdown in the housing market from 24 to 12 months. "I think that leads us to conclude so far that the speed at which the rate of increase will fall off ... will happen sooner," Mr Bean said.
Hanging over the whole event was the issue of UK membership of the euro in the wake of the news that the Government would announce its verdict on the five economic tests on 9 June. Mr King, who has a reputation as a sceptic, skilfully declined invitations to pass judgement. However, he said in terms of the imbalances that bedevilled the UK economy for several years, he welcomed the fall of the pound.Reuse content