fan chart fantasies

It is hard keeping up with the violent gyrations of the Bank of England economic forecasts. So far this year, the bank have produced three; each one radically different from the next.

The spring forecast offered a highly complacent perspective for the UK. Inflation and output risks were balanced. Despite the credit crunch, inflation would return to target, while the risks to output were contained.

With the August forecast, the balancing act was over. The UK had fallen off decisively on the inflation side. The CPI rate was about to surge beyond 5 percent and would only return to target by the middle of 2010. While the growth prospects were dimming, there was no talk of a recession.

Today's forecast (see above) lurches in another direction. According to the Bank, inflation is no longer the problem; the UK is now in recession. Moreover, the central forecast is for 6 quarters of negative growth, with the whole of 2009 being written off as a recessionary year.

Looking back at the August forecast, the bank made the right call on inflation; it did surge to a 16 year high, reaching 5.2 percent in September. As for new inflation forecast, the bank now expect a more rapid decline in prices. The CPI inflation rate will hit the 2 percent target sometime next year, a full 12 months earlier than the expectation in the August inflation report.

So what is it going to be? Inflation or deflation? Which is the bigger problem; recession or rising prices?

So far, so bad. Despite the so called radical policy gestures, the Bank of England has contrived to produce the worst of all worlds. The UK economy managed to hit a 16 year high in inflation, and now it is likely to fall into the deepest recession in a generation. So much for the MPC's balancing act.

However, the inflation report goes to great lengths to explain that none of this is the fault of monetary policy. It is all due to the credit crunch and the global financial crisis. Today's macroeconomic mess had absolutely nothing to do with the bubble economics that Brown, the BoE and the FSA practiced for the last 12 years upon the luckless UK economy.

So what is my take all this twisting and turning? The BoE inflation forecast depends heavily on a continued decline in oil prices and a collapse of the UK economy into a very nasty recession. If their inflation forecast proves to be correct then it confirms that the recent rate cuts were for Fleet Street; the 150 basis point cut made great headlines; but will have a negligible impact on the real economy.

However, the rate cut will undermine sterling; an issue that the Bank of England have dangerously underplayed in today's inflation report. If the exchange rate continues to slide, import prices will continue to rise, and then the BoE's rapid decline in inflation may look more like wishful thinking.

The growth forecast is shocking but recent real sector developments offer little confort. Unemployment is up, the 3rd quarter GDP number was negative, and the country as whole is smothered in a cloud of depression.

Personally, I doubt that inflation will come down quite as quickly as the bank thinks, but I fear that they might be spot on with their growth forecasts.