MPC dove accuses Bank of hugely overestimating risk of inflation

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A leading member of the Bank of England's interest rate-setting body yesterday launched an outspoken attack on its forecasting model, accusing it of overestimating inflation for almost four years.</p>In his most controversial speech since he joined the Bank, Sushil Wadhwani said inflation could tumble as low as 0.5 per cent within two years.</p>In a wide-ranging address Dr Wadhwani, acknowledged as the leading dove on the Monetary Policy Committee, also warned the recent revival on world stock markets could be short-lived and share prices were set for further falls.</p>His comments came as it emerged he considered voting for a three-quarter point cut in interest rates two weeks ago when the Bank opted for a half-point reduction. </p>In a speech to Edinburgh University Dr Wadhwani, who has voted for a rate cut at the last 10 meetings, said inflationary pressures were much lower than the Bank believed.</p>He said errors in the forecasting process meant inflation could come in much lower than the Bank's forecast of a return to its 2.5 per cent target.</p>Dr Wadhwani said if the average forecast error between 1998 and 2001 were overlaid on to the current forecast to late 2003, inflation could fall to 0.5 per cent.</p>"My personal judgement is that the current published best collective projection is overstating the degree of inflationary pressure," he said. "This suggests that there might still be important missing or poorly measured variables in the Bank's medium-term macroeconomic model and that there is much work for us to do."</p>This would not be the first time Dr Wadhwani has criticised the Bank. Two years ago he complained about the lack of resources for "outside" MPC members. </p>In his speech yesterday he also warned that stock markets looked over-valued despite the falls in share prices over the last 18 months.</p>Dr Wadhwani, who was research director at the Tudor hedge fund for four years until 1999, said investors' expectations of medium-term profits growth were too high.</p>"It does increase the risk to the stock market if the economic recovery were delayed," he said. "Moreover, over the medium-term, a downward valuation adjustment may still be necessary."</p>The minutes of the MPC meeting two weeks ago showed Dr Wadhwani joined the majority in voting for a half-point rate cut. Only Ian Plenderleith voted for a quarter-point. They revealed that the MPC felt driven by the need to shore up confidence among businesses and consumers. The word "confidence" was mentioned 17 times in the minutes.</p>There was a prolonged debate between a quarter and a half-point cut with some members worried about basing a decision on surveys that were notoriously volatile and which misread the global financial crisis of 1997 and 1998.</p>In the end it decided the surveys were unlikely to bounce back, concluding: "A half-point might do more to underpin confidence domestically by underlining the committee's continued readiness to act."</p>Meanwhile, the European Commission followed the IMF and OECD in forecasting a slowdown in growth to around 1.7 per cent, well above the European Union average.</p>But the pain in the UK's corporate sector was highlighted by official figures showing business investment fell 4 per cent in the third quarter.</p>The recession-hit manufacturing sector suffered a fall of 13 per cent, its worst drop since records began in 1994. Stephen Radley, chief economist of the Engineering Employers' Federation, described it as "shockingly bad".</p>"Whilst the Bank is doing its bit by reducing rates, it reinforces the need for the Chancellor to announce measures in his pre-Budget report that will assist investment, reduce business costs and boost business confidence," Mr Radley said.</p>