Where will the next shock come from?

ECONOMIC VIEW; Then, of course, just when the markets are convinced all is well, there will be some sort of disaster

Surprises make people money. Or rather they make money for people whose job it is to deal in the financial markets, for once an item of news is "in the market" there is no turn: what matters in the narrow perspective of markets is not whether figures are good or bad in themselves but whether they are better or worse than expected.

There are therefore two games which anyone interested in markets ought to play. One is fun. It is to keep asking themselves where the next potential surprise might come from: a figure, a change of policy, maybe just a change of fashion. The other is (usually) less fun. It is to look back at one's own views and see where one has got things completely wrong. More of the former in a moment, focus first on the latter.

Up to now there has been very little ordered analysis of the performance of economic forecasters. People do rankings of individual forecasts for the UK economy - who got things right and who got them wrong. Expect the results of an interesting little exercise of this nature to be published in this paper on Wednesday. But they do not look at the generality of forecasts and plot where the consensus has been optimistic and where it has been pessimistic. So a new indicator developed by the investment bankers Kleinwort Benson deserves a welcome: the surprise activity indicator.

The idea is very simple. You take the consensus forecasts each month for several indicators of the UK economy and then compare these with what actually happens. You can then see whether forecasters as a whole have been over-optimistic or over-pessimistic about the UK economy. Kleinwort has drawn up a composite indicator based mainly on gross domestic product, retail sales, industrial output, unemployment and money supply, the results of which over the last two years are shown in the surprise activity indicator graph.

You can see that for the whole of 1994 things turned out better than expected: the economy grew faster, inflation was lower, unemployment declined more quickly. If you think back, everyone started the year wondering whether the recovery would be sustained and how long it would be before unemployment stopped rising. We ended up with growth of nearly 4 per cent.

Last year proved the reverse. Everyone thought that the low-inflation boom would continue, whereas growth faltered and the inflation numbers rose. When the Treasury came out with a 3 per cent growth forecast in the November Budget, it was dismissed as unduly rosy.

Now, once again, things are beginning to turn out better than expected: the three-month moving average has just blipped positive. This raises the intriguing possibility that the year as a whole might turn out better than expected, for there does seem to be some sort of "fit" between surprises and out-turn. Indeed, better than that: changes in the surprise indicator seem to be a lead indicator for changes in economic growth.

The period from 1988 onwards is plotted on the other graph. Anyone who is interested in statistics will notice that quite a bit of pushing around of the figures has gone on to make the two series fit as well as they do. It seems that you have to take a 12-month moving average for the surprise indicator rather than a three-month one; you use non-oil GDP, which is fair enough; you have to fiddle with the scales and you have to put the zero on the surprise indicator at just under 2 per cent on the growth side. But once you have done all that, hey presto, there is a nice three or four-month lead indicator of the turn of the recession in 1991 and a slightly less clear indicator of the slowdown in growth that took place last year.

Most interestingly there is a hint now that the growth pause of last year may soon be over. We will have to see whether the surprises continue to be on the positive side, but the much-derided Treasury forecast appears a wee bit more credible now than it did in November. Kleinwort will carry on monitoring this series and I will update people in the next few months if anything interesting emerges.

What about the second game noted above, the "where will the next one come from?" Here there is not much to be done by feeding numbers through computers and trying to spot relationships - you just have round up the potential suspects and nab the ones that appear promising. Kleinwort suggests that higher growth will surprise us on the upside by the middle of the year, but that inflation expectations will rise too on the back of this, which would presumably be bad for gilts.

My own list of candidates would certainly include higher growth this year, but I would be more concerned about the balance of payments than inflation, as British consumers always tend to want to buy imported goods when they become a bit richer. My worries for the bond market would come from political uncertainty rather than current inflation.

But the most interesting surprises, surely, go beyond the range of the Kleinwort Benson exercise, for they will be external ones. In the broad scheme of things the British economy is not very important. What matters are the grand global changes of mood which occur from time to time.

Some examples. A year ago only the brave predicted that EMU might have to be postponed or even abandoned. Now the former is seen as odds-on, while the latter is something close to an even bet. Few people saw the French riots coming, and the consequences of that are still unclear.

There are potential surprises in the energy market (the oil price falling off a cliff?), and more generally in commodities (ditto?). Forecasts for the German and French economies have been revised down so dramatically that I suppose the most surprising thing there would be for a year of adequate growth. That would at least be more surprising than actual recession on the Continent, which at the moment looks all too possible.

Finally, there remains the future of the long, long bull market in US securities. As each month of higher Wall Street prices passes the quietly whispered possibility of a speculative blow-off in US share prices, followed by a crash, becomes more likely: the surge running on and on until the music suddenly stops. Maybe the potential surprise there would be for the bull market to continue intact through 1996 and well into 1997.

But all this goes far beyond the scope of the Kleinwort exercise. The most useful conclusion that flows from that is that if the pattern of the last few years continues, we should expect several more months, perhaps a year, of better performance from the British economy than the markets at present expect.

Then, of course, just at the moment when the markets are convinced that all is well, there will be some disaster.

Start your day with The Independent, sign up for daily news emails
News
The guide, since withdrawn, used illustrations and text to help people understand the court process (Getty)
newsMinistry of Justice gets law 'terribly wrong' in its guide to courts
News
Bobbi Kristina Brown with her mother Whitney Houston in 2011
people
News
Starting the day with a three-egg omelette could make people more charitable, according to new research
scienceFeed someone a big omelette, and they may give twice as much, thanks to a compound in the eggs
News
Top Gun actor Val Kilmer lost his small claims court battle in Van Nuys with the landlord of his Malibu mansion to get back his deposit after wallpapering over the kitchen cabinets
people
PROMOTED VIDEO
News
The actress Geraldine McEwan was perhaps best known for playing Agatha Christie's detective, Miss Marple (Rex)
peopleShe won a Bafta in 1991 for her role in Oranges Are Not The Only Fruit
News
newsPatrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad
News
Robert Fraser, aka Groovy Bob
peopleA new show honours Robert Fraser, one of the era's forgotten players
Life and Style
Torsten Sherwood's Noook is a simple construction toy for creating mini-architecture
tech
Sport
David Silva celebrates with Sergio Aguero after equalising against Chelsea
footballChelsea 1 Manchester City 1
News
i100
ebooks
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Software Development Manager

£40000 - £50000 per annum: Recruitment Genius: This is an exciting opportunity...

Ashdown Group: Product Manager - (Product Marketing, Financial Services)

£30000 - £35000 per annum + Benefits: Ashdown Group: Marketing Manager - Marke...

Recruitment Genius: Compliance Assistant

£13000 per annum: Recruitment Genius: This Pension Specialist was established ...

Ashdown Group: Market Research Executive

£23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

Day In a Page

As in 1942, Germany must show restraint over Greece

As in 1942, Germany must show restraint over Greece

Mussolini tried to warn his ally of the danger of bringing the country to its knees. So should we, says Patrick Cockburn
Britain's widening poverty gap should be causing outrage at the start of the election campaign

The short stroll that should be our walk of shame

Courting the global elite has failed to benefit Britain, as the vast disparity in wealth on display in the capital shows
Homeless Veterans appeal: The rise of the working poor: when having a job cannot prevent poverty

Homeless Veterans appeal

The rise of the working poor: when having a job cannot prevent poverty
Prince Charles the saviour of the nation? A new book highlights concerns about how political he will be when he eventually becomes king

Prince Charles the saviour of the nation?

A new book highlights concerns about how political he will be when he eventually becomes king
How books can defeat Isis: Patrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad

How books can defeat Isis

Patrick Cockburn was able to update his agenda-setting 'The Rise of Islamic State' while under attack in Baghdad
Judith Hackitt: The myths of elf 'n' safety

Judith Hackitt: The myths of elf 'n' safety

She may be in charge of minimising our risks of injury, but the chair of the Health and Safety Executive still wants children to be able to hurt themselves
The open loathing between Barack Obama and Benjamin Netanyahu just got worse

The open loathing between Obama and Netanyahu just got worse

The Israeli PM's relationship with the Obama has always been chilly, but going over the President's head on Iran will do him no favours, says Rupert Cornwell
French chefs get 'le huff' as nation slips down global cuisine rankings

French chefs get 'le huff' as nation slips down global cuisine rankings

Fury at British best restaurants survey sees French magazine produce a rival list
Star choreographer Matthew Bourne gives young carers a chance to perform at Sadler's Wells

Young carers to make dance debut

What happened when superstar choreographer Matthew Bourne encouraged 27 teenage carers to think about themselves for once?
Design Council's 70th anniversary: Four of the most intriguing prototypes from Ones to Watch

Design Council's 70th anniversary

Four of the most intriguing prototypes from Ones to Watch
Dame Harriet Walter: The actress on learning what it is to age, plastic surgery, and her unease at being honoured by the establishment

Dame Harriet Walter interview

The actress on learning what it is to age, plastic surgery, and her unease at being honoured by the establishment
Art should not be a slave to the ideas driving it

Art should not be a slave to the ideas driving it

Critics of Tom Stoppard's new play seem to agree that cerebral can never trump character, says DJ Taylor
Bill Granger recipes: Our chef's winter salads will make you feel energised through February

Bill Granger's winter salads

Salads aren't just a bit on the side, says our chef - their crunch, colour and natural goodness are perfect for a midwinter pick-me-up
England vs Wales: Cool head George Ford ready to put out dragon fire

George Ford: Cool head ready to put out dragon fire

No 10’s calmness under pressure will be key for England in Cardiff
Michael Calvin: Time for Old Firm to put aside bigotry and forge new links

Michael Calvin's Last Word

Time for Old Firm to put aside bigotry and forge new links