Sunday, November 16, 2014
The Bank conjures up a sweet spot for Osborne
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The Bank of England’s latest quarterly inflation report has attracted a lot of comment, mainly because it confirmed the Bank’s “lower for longer” view on interest rates and because of an upbeat assessment of prospects for wage inflation.

What has received rather less attention is that, even apart from its views on wages, the Bank has set out an economic scenario which any chancellor would die for. If the Bank is right, the main risk of the sweet spot it sees for the economy in election year is that it will be too sugary.

Consider the evidence. The Bank’s forecast for growth next year is 2.9%, close enough to 3% to make no difference. Unemployment, now 6% of the workforce, will continue its fall, to 5.4%, on its way down to a near-normal 5% rate.

Inflation, after a period in which Labour has based its pitch to voters on the so-called cost of living crisis, will run at close to 1% over the next year, the Bank expects, with Mark Carney, the governor, saying it is “more likely than not” that he will have to write an open letter to George Osborne, explaining why it has dropped below 1%.

This will be a significant moment. There have been 14 open governor-chancellor letters, all of them from Mervyn (now Lord) King, during the 2007-2012 period. All of them were to explain why inflation was more than a percentage point away from the 2% target on the upside; an overshoot.

Never has a governor had to explain an undershoot, because consumer price inflation has never been below 1% in the time it has been the official target. Food and petrol prices are falling and household energy inflation has slowed to a crawl.

The Bank cannot do anything about the eurozone crisis, Carney’s “spectre of economic stagnation” but it does expect a continued strong recovery in business investment; up 10% next year.

Productivity, the dog that has not barked so far in this recovery, will not exactly be howling. The Bank expects a rise of only 0.75% next year, similar to this, followed by 1.5% in 2016. But it is heading in the right direction.

And then there are those wages. 2% wages growth alongside 5% inflation, which we had not so long ago, was a Micawberite recipe for misery. Wage growth of 3.25% alongside inflation of roughly 1% is the macroeconomic equivalent of Mr Micawber’s recipe for happiness.

And, of course, though two members of the Bank’s monetary policy committee have been voting to raise interest rates, most seem set to sit on their hands until autumn of next year. Carney’s original forward guidance of August 2013, which pointed towards 2016 as the most likely date for the first interest rate hike, may end up coming good. Mind you, it has been a bumpy ride.

The Bank would not, of course, accept for a moment that either its forecast or the fact that interest rates now seem to be on hold until after the election have anything to do with politics. One way to rile its occasionally tetchy governor is to suggest that his forward guidance has not been an unalloyed success. Another is to accuse him of political motives.

Forecasts are forecasts, and the Bank’s forecast, that the recovery will be supported by rising real wages, buoyant consumer confidence and strongly rising investment may turn out to be wrong.

Nor would I suggest for a moment that this pre-election sweet spot for the economy reflects Osborne’s pinpoint planning. This is more of an accident than a master strategy. The chancellor did not expect or want real wages to be depressed for so long, or for the economy to be so slow to get into its stride.

Indeed, over the next few months we may find out something useful about the lags between economic change and public perception. The default position of voters is to be curmudgeonly. Even when times are good people are reluctant to concede it. Our YouGov polls show that most people think the economy is in a bad way and that the recovery has yet to lift the Tories’ poll rating, though it may have knocked Labour’s. It will take a long time before the so far tiny recovery in real wages starts to feed through to public perceptions. It should gain strength, but it may have come too late.

Osborne also has a tricky hurdle to negotiate on the budget deficit, though it is not something that keeps many voters awake at night. Official figures this week for the public finances will be important. They are the last before the Office for Budget Responsibility does its calculations for the December 3 autumn statement, and they will show whether the Exchequer is getting a boost from corporation tax revenues.

I think the coalition has a pretty good story to tell about deficit reduction. According to the latest International Monetary Fund fiscal monitor, the cyclically-adjusted deficit has come down from 10.3% of gross domestic product in 2009 to 4.1% this year, a big reduction. One reason is that there is still a lot left to do is that Osborne toughened his own target, aiming for an overall budget surplus in the next parliament rather than just eliminating the current deficit.

As for reports that Treasury officials are unsettled by the tax promises made by David Cameron and others, I should tell you that the Treasury always gets unsettled at this stage in the political calendar. Last time some of them were very troubled by fears of a Gordon Brown victory.

Even so, the budget deficit remains worryingly close to £100bn and, like the Tory poll rating, is not being moved much by economic recovery. Stronger growth in wages will help but low inflation will depress other tax receipts, notably VAT.

Osborne will still have a good economic story to tell in his autumn statement on December 3. The sweet spot contained in the Bank’s forecasts is, as I say, better than he could have expected. His message will be that the sacrifices have been worthwhile and the economy is reaping the benefits, His message on the deficit will be that there is still a lot of work to be done, and that only he can be trusted to do it.

Whether it works politically remains to be seen.