'Events, dear boy, events." Bank of England Governor Sir Mervyn King may feel justified in borrowing from Harold Macmillan this week, when he presents the Old Lady's inflation and growth forecasts in a far different climate to his last quarterly update in May.
Just three months ago, the mood music from the monetary policy committee was relentlessly downbeat, as rate-setters were gripped by a spring neurosis over inflation. No longer. It smacked more than a little of panic as the MPC raised its central forecast for the consumer prices index dramatically from 1.9 per cent to 2.9 per cent by the end of this year. Deputy governor Paul Tucker warned the cost of living would linger over 3 per cent into the second half of 2012. Even Adam Posen, until then a confirmed dove, caught the bug as he voiced fears over inflation and temporarily withdrew his calls for more stimulus.
Since then, oil prices have fallen some 25 per cent from their peak to $90 a barrel in mid-June, before retracing slightly to top the $100 mark at present. The CPI now stands at 2.4 per cent and should even renew acquaintance with the MPC's 2 per cent target for the first time in three years by the end of 2012, confounding the pessimistic expectations of most rate-setters weeks earlier.
Two turbulent Greek elections, and a banking bailout for Spain have blemished an already gloomy picture in Europe. US growth is stuttering and China is growing at its slowest pace for three years. Sterling has risen against the euro and against a trade-weighted basket of currencies, which is also good for bringing down inflation. No wonder Sir Mervyn recently told MPs that he was "very struck by how much has changed".
In one sense, it makes a pleasant change for the Bank to be downgrading its inflation forecasts after years of embarrassing overshoots. But its over-optimistic growth forecasts will also be severely trimmed. As recently as May the Bank was predicting 1 per cent growth for the UK this year, and the MPC was outspoken with its doubts over the Office for National Statistics' growth forecasts. This bullishness is now conspicuous by its absence. After the ONS's verdict of a 0.7 per cent decline between April and June, Deutsche Bank's chief UK economist George Buckley points out that if the economy made all of that ground back between July and September and then pencilled in a 0.4 per cent advance in the final quarter of the year, we still arrive at a decline of some 0.5 per cent for 2012.
This would not only be a disastrous outturn for the Bank, but a serious blow for the Office for Budget Responsibility, which is counting on a still-modest 0.8 per cent advance this year. That blows a hole in the public finances that may require more cutting and tax hikes to rectify.
The MPC's long-run forecasts of inflation for next year and 2014, around 1.6 per cent and 1.7 per cent according to its fan charts, look more sound. The committee should leave these relatively unmoved, which gives it some breathing space for more quantitative easing in the autumn if necessary, or, less likely, halving interest rates to 0.25 per cent. But there are still unanswered questions over inflation worrying the hawkish minority on the committee. External member Ben Broadbent and the Bank's chief economist Spencer Dale withheld support for July's £50bn burst of QE, arguing recent falls in the pace of inflation were largely down to lower oil prices and urging caution until the effects of the £80bn Funding for Lending scheme become clear.
One unsettling problem that needs answering before the MPC embarks on any more stimulus is why services sector inflation, at 3.3 per cent, remains so high. Goods are mostly imported and more subject to global ebbs and flows and fluctuation in the currency. Services should be influenced to a lesser degree by these volatile factors: if the MPC's central premise that a wide output gap should be dragging down prices holds, surely we should be seeing bigger falls in this area by now?
There is obviously huge variation in such a wide-ranging sector. Transport costs are growing by 5.6 per cent a year, while home insurance is down 4 per cent year-on-year. But I would have expected the apparent slack in the economy to be making more of a mark here by now. It may be that companies struggling to obtain, or unwilling to rely on, bank credit are taking the opportunity to maintain profit margins; if so we may struggle to bring down underlying inflation.
It should also be said that falling inflation may not be the panacea that the Bank and the Treasury are pinning their hopes on to spur growth. The cost of living has slipped back, but is still running ahead of average wage growth, 1.8 per cent in the quarter to May. Hence workers are still contending with real-terms wage cuts. Prospects for consumer spending are brighter than at the start of the year but with unemployment still high, insecurity hovers over many households, particularly public-sector workers. House prices falling at their fastest pace for three years, according to Nationwide, hardly help to inspire confidence.
The irony of this week's inflation report is that as soon as the Bank has taken a red pen to its forecasts, other threats may emerge to push them higher. The British Retail Consortium's shop price index put food price inflation at 3.1 per cent in July, the lowest since 2010, but droughts in the US may ratchet up the pressure on the weekly shop. And if the falls in oil prices seen in the past three months aren't repeated next year, this will add to inflationary pressure.
Of course, any easing in the cost of living is good news for inflation-watchers and households alike. But the MPC shouldn't flatter itself by thinking we're out of the woods quite yet.
Bank of England is doing its best to help sad Britain cheer up
All hail mother's little helper. At a time when the Office for National Statistics is spending £8m on a four-year project to assess how happy we are as a nation, sales of antidepressants are soaring.
NHS figures showed 46.7 million prescriptions for antidepressants last year, a rise of 9.1 per cent on 2010. While the increase looks alarming, a look at the historic data is a little more reassuring. Between 1991 and 1992, a shallower but far more painful recession, the number of dispensed prescriptions jumped 44 per cent year-on-year. Compare this with the rough mid-point of the Bank of England's so-called "Nice" decade of non-inflationary consistent expansion: between 2003 and 2004, prescriptions edged up a mere 4.5 per cent, according to the NHS numbers.
What can we say about this in a broader economic context? First, hats off to the Bank of England for doing its bit to preserve the mental health of the nation with its handling of the most recent recession. It certainly helps when interest rates are at 0.5 per cent rather than 15 per cent. Compared with the early 1990s – when dole queues soared above three million, business insolvencies hit a record high and more than 75,000 people lost their homes – a deeper recession this time has produced a much lower human cost, thanks to the monetary activism of an independent central bank.
Second, the NHS prescriptions may be another symptom of that missing elixir for the British economy at the moment: confidence. While more buoyant unemployment figures have raised doubts over official figures showing an apparent recession, the closely watched GFK-NOP consumer confidence index has been stuck in recessionary territory for a year. Falling inflation may eventually improve this, but household spending accounts for two-thirds of our economy. Until they – and nervous cash-hoarding businesses – pull out of their despond, the recovery will struggle to gain momentum. At least the ONS will be able to say exactly how miserable we are to two decimal places.