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unchanged. By comparing the two forecasts it is possible to infer
how realistic the bank judges market expectations to be.
The City had been expecting the base rate to rise next year, to
reach just over 2% by the end of 2010 and to carry on rising in
2011. On this basis, consumer-price inflation would be below the
2% target in two years’ time—the period it normally takes for
monetary policy to have its full effect on prices (see chart 2). If
instead the base rate were held at 0.5%, inflation would be hitting
the target in mid-2011. In practice the bank is highly unlikely to
keep interest rates on hold in this way, but it does not have to
raise them as quickly as the markets had been expecting.
One worry about the
programme of quantitative
easing is that it will stoke
inflation. The bank’s
inflation forecasts suggest
that such a concern is
unwarranted. The recession
has been so severe that a
big gap has opened up
between the productive
capacity of the economy
and actual output. While
this persists it will constrain
inflationary pressures—and
given the gap’s size, it is
likely to last a long time,
even with a healthy
recovery.
As if to underline the point, official figures on the labour market published on the same day as the bank’s
report showed earnings (excluding bonuses) rising by only 2.5% in the year to the second quarter,
compared with 3.8% a year earlier. That is unsurprising given the damage wreaked by the recession.
There was a record fall in employment of 271,000 between the first and second quarters of 2009. And
unemployment rose to 7.8% of the labour force in the second quarter, up from 5.4% a year earlier. That
brought the total number of jobless up to 2.4m, the highest since 1995. John Hawksworth, an economist
at PWC, an accountancy firm, says unemployment is on course to reach 3m next spring.
Mr King may be rather more confident about an upswing in the near term, but he continues to worry
about whether it will prove sustainable further ahead. Banks still have much work to do to repair their
ravaged balance-sheets, which will limit their ability to lend. Meanwhile, a fragile banking system remains
vulnerable to further shocks. The Bank of England’s report identifies “persistent weakness in bank lending”
as a downside risk to spending over the next three years.
So much still to worry about
Households must also sort out their finances after a decade of overborrowing. They will need to save more
both to make up for falls in wealth and to keep more aside in case they become unemployed. Higher
saving together with subdued earnings “is likely to result in relatively weak household spending growth”,
says the bank.
There are other risks. The bank is expecting net trade to bolster the recovery, as exporters press home
their gains in competitiveness once foreign markets recover. But, as the report points out, “the outlook for
global demand is highly uncertain,” not least since other countries are facing the same difficulties. A world
recovery may also prove fragile if it prompts big commodity price rises.
The Bank of England’s overall prognosis may appear gloomy; but it is realistic. The recession has taken a
terrible toll on output, which has fallen by 5.7% since the start of 2008. The genesis of the downturn—a
financial crisis that came close to toppling Britain’s banking system—is one that augurs ill for a robust
recovery. Moreover, the emergency monetary and fiscal treatment must eventually be withdrawn, which
will create moments of peril ahead. With an election due by the middle of next year, Labour and the
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