Sunday, December 28, 2014
A better year than most expected
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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The table to accompany this piece is available on www.thesundaytimes.co.uk

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

What did we make of that? Whether we should lay it down and save it for later (rather than lay it down and forget it, as for some recent years) , there is no doubt that 2014 was a good year for the economy. It started well and ended better. A year ago there were doubts about whether the recovery starting to build would last. Now we know it did.

The job market continued to perform minor miracles, with the latest figures showing a rise in the number of people in work of 588,000 over the past year, 95% of them full-time roles. Unemployment has dropped by more than 450,000.

The icing on the cake was provided by the drop in oil prices in the final months of the year and the consequent weakness of inflation. Strong growth and low inflation are an unusual combination. At the end of the year Britain has an economy growing by 3% alongside inflation of just 1%.

That November inflation rate of 1% will not mark the low point for inflation in this cycle; Mark Carney has his inkwell filled ready to write that letter of explanation next month when it drops further. It is also one reason why real wages – earnings adjusted for inflation – have begun to rise in recent months.

I took part in a debate organised by the Resolution Foundation in January in which there was unanimity that 2014 would be the year of the real wage rise. All the panellists have been saved from red faces. Eventually 2014 was the year of the real wage rise.

On interest rates, things blew a little hot and cold. This time last year we were still in the early phase of Mark Carney’s forward guidance, which pointed to no rate rise until 2016 (conditional on unemployment no falling too fast).

Though markets were sceptical about the Bank of England’ forecasts given the pace of the fall in unemployment even 12 months ago, few expected an early move in rates. That changed in June, the Bank governor’s Mansion House speech, in which h he appeared to point the way towards a hike before the end of this year. Things move on from that, but only as far as an early 2015 hike by the start of autumn. Now are close to coming full circle to the original guidance.

Who successfully steered their way through all these hurdles? Regular readers will know that for very many years, going back to the 1990s, I have been running an annual league table for forecasters, based on their ability to get closest to the outcomes – or what we current believe to be the outcomes – for the traditional four goals of economic policy; growth, inflation, unemployment and the balance of payments, together with one of the instruments of policy – interest rates.

People have asked me why I do not include other important variables like the budget deficit. This is not due to Ed Miliband-style amnesia but simply because, while the deficit is clearly very important, the timing is wrong. We do not get a decent handle on the outcome for the budget deficit for the fiscal year until almost the middle of the calendar year.

A word on the data used in this year's comparison. Two days before Christmas the often-exasperating Office for National Statistics had one of its periodic bouts of revision madness, just a few weeks after a huge shake-up of the gross domestic product figures.

Its revisions, going back to 2013, will initially make 3% growth for 2014 more difficult to achieve though I and the Bank of England have no doubt that in the fullness of time 2014 growth will be at least that. As last year, when the revisions were in the other direction, it is unfair that forecasters are judged on the whims and timing of the official statisticians' revisions. We have been a 3% growth economy for many months.

That was the Office for Budgets Responsibility's December number, and the consensus among independent economists two weeks ago. So it is the number I use for the comparison.

Similarly, while the pre-Christmas balance of payments figures will probably push up the current account deficit for 2014, I have stuck with the December consensus figure (few were close to even the smaller deficit anyway).

Anyway, who got the economy right in 2014? This year’s clear winner was Capital Economics. Many years ago Roger Bootle, its founder, wrote a book called The Death of Inflation. Forecasting that inflation would have another near-death experience was one of the reasons for Capital’s triumph.

It is not its first success. It topped the table in 2005, came second in 2011, and has done well in other years, interspersed with the occasional off year.

Mention should also be made of Peter Spencer and his colleagues at the EY Item Club, sponsored by the accountants formerly known as Ernst & Young. Item stands for independent Treasury economic modellers, named because when the Treasury model was made available to outside users many years ago, a group of businesses got together to use it to forecast the business climate.

Things have changed. The Office for Budget Responsibility is now the official forecaster and Item has had to adjust. But it is still turning out good forecasts.

I must also mention Kevin Daly and his team at Goldman Sachs and Michael Saunders at Citigroup, third and fourth. Goldman topped the table last year, which can sometimes be a prelude for a slump to the bottom of the table next time. To stay close to the top shows skill and tenacity. The same is true for Citigroup, and regular strong performer over the years.

Where did forecasters go wrong? Mainly by overestimating inflation. At the start of the year most forecasters expected inflation to stay above the official 2% target, in some cases significantly so. Some thought Carney would have to write an open letter explaining an inflation overshoot. In fact, inflation dropped below the official target in January and has stayed below it all year. For once, it surprised on the downside.

How did I do? My forecasts, published on January 5, were for 2.75% growth, 1.75% inflation, 1m unemployment and Bank rate staying at 0.5%. The one I got wrong was the current account, which I expected to narrow to £42bn rather than widen further.

That forecast would have been enough for eight points, enabling me to share the glory with Capital Economics. But that would be unwary. You cannot be judge, jury and winner at the same time.

So congratulations to Capital, and to the forecasters who ran them close. Next year promises to be just as challenging, if not more so.