Against this background, the MPC's objective was clear - to get overall GDP growth down to its long-term sustainable rate from the unsustainable rates seen through most of last year. With growth in the first half of the year coming in at an annualised rate of around 2 per cent, this objective has been broadly met.
Recent comments from some MPC members, however, suggest that the objective itself has been re-assessed. In particular, comments that unemployment has probably now fallen below the non-accelerating inflation rate of unemployment (NAIRU) suggest that at least some members of the MPC now believe that the output gap is significantly positive. If this interpretation is correct, the implications for policy are potentially dramatic. Growth slowing to trend is not enough - a relatively hard landing for the UK economy could be beginning to look like a policy objective.
So where are we to look for the first signs that the gentle slowdown in overall activity seen so far is turning into something more akin to the recessions of the early 1980s or early 1990s? The range of leading indicators of economic activity in the UK is not as broad as it was - the Office for National Statistics (ONS) discontinued the official composite leading indicators some time ago after an investigation revealed they had little predictive power. And unpredictable shifts in velocity have made the monetary aggregates of little use in predicting turning points in activity, as the Bank of England has implicitly admitted by dropping monitoring ranges for both broad and narrow money. This leaves indicators of confidence - consumer and business - as the main leading indicators of economic activity in the UK.
According to the latest CBI Industrial Trends Survey released last week, July saw a veritable collapse in business confidence, with the balance of optimists against pessimists falling to its lowest level since 1991. Overall business optimism is now at a level historically associated with falling GDP, as the chart shows. Two caveats, however, need to be added to this. First, because the survey covers only manufacturing industry it may well be overstating the weakness of activity overall as services output remains solid. Certainly, the downturn in more broadly-based surveys - such as those from the Chambers of Commerce and Dunn and Bradstreet - has been much less marked.
Second, those parts of the CBI survey that relate to the level of activity rather than the growth rate, while softening in recent quarters, continue to suggest that capacity remains fairly tight. In particular, the number of firms reporting skilled labour shortages remains historically high despite the recent weakness of output and falling employment intentions. Quite possibly, this reflects the strength of demand for skilled labour in services and the ease with which many skilled workers are able to move between sectors now.
Again, therefore, the CBI survey seems to confirm that growth is set to slow - possibly very sharply - but there is little evidence that the absolute level of activity is sustainable at present.
One further factor points to an increasingly unhealthy picture in industry - the financial position of the corporate sector. As the chart shows, industrial and commercial companies (ICCs) moved into financial deficit last year and in the last two quarters have seen deficits of close to 2 per cent of GDP. The ICCs' financial deficit was probably the single most important lead indicator of the early 1990s recession - companies' finances had become so stretched that sharp declines in capital spending and employment were almost inevitable.
Clearly the current deficit does not look nearly as worrying as that of the late 1980s and early 1990s, but the trend is not encouraging. Historically, the ICCs' financial balance has led GDP growth by around a year and deficits of 3 per cent of GDP or more have eventually been associated with falling output. The state of company finances does not argue for panic and the prospect of an imminent hard landing, but there is little doubt that the balance of risks is changing and could be changing quite quickly.
So much for industry. What about consumers, who arguably are the beneficiaries of sterling's strength as import prices have fallen, boosting real incomes. Recent press reports based on the MORI Economic Optimism Index have suggested that consumer confidence in particular has "collapsed". The fall from +1 to -19 between May and June in the optimists-pessimists balance is certainly dramatic, and was sustained in July. However, at current levels the survey is still pointing to weakly positive retail sales growth, rather than absolute falls in volumes. And the broader measure of confidence published by the European Commission remains at levels consistent with strong growth in sales.
So the evidence for an imminent collapse in consumer spending is far from convincing. But the data does highlight the case for a sharp slowing in consumer spending in the second half of the year as consumers respond to higher base rates, higher taxes (at least marginally) and an ongoing deceleration in the rate at which unemployment is falling. Add to this a further fading in the impact of last year's windfalls, and a sharper slowdown in consumption than current forecasts imply is not difficult to envisage.
Over the coming months, indicators of consumer and industrial sentiment need to be monitored carefully. Talk of confidence having "collapsed" probably overstates the severity of the deterioration in recent months. But when confidence started to fall in the early 1990s, the deterioration was rapid indeed.
It is not clear what role reports of falling business and consumer confidence played in the MPC's decision to leave rates on hold last month, or what role they might play at next week's MPC meeting. But as indications of how hard a landing we can expect, and how soon rates can fall, changes in business and consumer sentiment will be amongst the most important over the coming months. If the early 1990s recession taught us anything, then it was probably that at important turning points in activity, businessmen and consumers often spot something coming before economists do.
Adam Cole is UK Economist at HSBC Economics and Investment StrategyReuse content