I don't usually write you commentaries on the Bank of England's inflation report - you don't pay me enough for that. And I'm not going to offer you much detail today. But a few points from it are so striking that you really need to get hold of them.
First, here's Chart 5.2: GDP projection based on constant nominal interest rates at 3%:
What does it say? It says that the Bank is now expecting GDP to contract 2% from October 2008 to September 2009, and it thinks there is a 15% or so probability that GDP will contract by more than 3% in that period. If you compare Chart 5.2 with Chart 5.1 (GDP projection based on market interest rate expectations - which were higher) we can see the point that we knew - lower interest rates are not expected to have any effect upon this phase of the recession. Their effects (such as they are) will come later.
Next, let's see Chart 5.5: CPI inflation projection based on constant nominal interest rates at 3%:
This one says that the Bank expects inflation to drop below 1% by 2010 (at current interest rates), and that there is a 25% chance of deflation by that point. That's pretty sanguine, in my view. This morning's FT reports the "break even inflation rate" for UK 2.5% 2011 bonds - i.e. the inflation rate between now and 2011 at which one would be indifferent between index linked and non-index-linked bonds, which is a measure of the inflation rate that the market expects over that period - as -0.91% (i.e. financial markets are expected deflation of around a percentage point between now and then). The Inflation Report notes (p11) that "in 2008 Q3 annual real broad money growth was negative, for the first time since the early 1980s". So we are in the mother of all monetary slowdowns, comparable with a period of policy-induced real contraction that got inflation from above 20% down to less than 4% in under three years. I think deflation is nailed on. The only question is how much.
At the press conference, Governor Mervyn King is reported by the BBC as saying that there was "a stronger argument for fiscal stimulus than previously, because the banking crisis had meant that monetary policy was less likely to be effective". I don't see any references to him saying that "the cupboard is bare" or that it would be impossible to finance a fiscal stimulus because no-one will lend us the money. He did warn (as I have done) that "any short-term fiscal stimulus had to be consistent with the long-term path of fiscal discipline. Otherwise...long-term interest rates would rise, undoing some of the effects of any economic boost." So now our Frontbench team has set itself against the Governor of the Bank of England. They say fiscal stimulus is impossible. He says it's possible. He's right.
P.S. Looking at this morning's press coverage of our new jobs subsidy proposal, I'm reminded of that sad moment in Strictly Come Dancing when you become aware that a dancer is really finished. You know what I mean: when the judges all say nice things about the dancer ("I was entertained"; "A good effort"; "Well done") but then when the scorecards come up it's "4, 5, 5, 6". I have this horrible feeling that the journalists are on the point of giving up expecting any better from our Treasury team, and may shortly start making encouraging noises of the "a good effort, considering..." nature. We need to turn this around, fast.
