The last couple of days has seen me analyse both accountancy chicanery and yet another “surprise” rise in inflation in the UK. It has had the side issue of adding the word “spike” to my financial lexicon. Today we will receive the inflation report from one of the worst forecasting bodies in the world which is the Bank of England. It is already being treated with far more seriousness than it deserves. For example Stephanie Flanders of the BBC has pointed out that the Bank of England could tell us that inflation might go up or down with the clear implication that it matters what they say. But taking these reports seriously like that is to make a mistake yourself. We do get a clue to likely Bank of England policy from these reports however we do not get any sort of guide to how the future will turn out unless you use it as an anti guide!
How bad is the Bank of England’s record?
It is simply shocking and I will illustrate by using the forecasting time period of two years and go back therefore to the Inflation Report of November 2010. Just to be clear the reason for the two-year period is that it is the period over which leads and lags operate before monetary policy changes operate at full power.
We see in the Governor’s introduction two regular themes
Over this period, the (inflation) projection is higher than in August
Yes they had underestimated future inflation yet again but in another regular theme (something Stephanie Flanders shares) we get this.
Further ahead, CPI inflation is projected to fall back
Okay so they may have had and let’s be polite, a little bit of trouble as Frank Spencer used to say, with inflation what about economic growth?
Overall, growth is judged to be a little more likely to be above its historical average rate than below it for much of the forecast period
As you can see the discussion of historical averages gives the implication of say 2.5% economic growth per year over the following two years. Indeed they say over that which gives us 5% plus. Actually UK GDP has risen from 102.4 in the third quarter of 2010 to 103.0 in the third quarter of 2012, so unless we are going to see 5% economic growth in the fourth quarter of 2012 the performance in the economic growth area is even worse than the inflation one!
What did they forecast for now?
Having got the period between then and now completely wrong there is of course the possibility that we might now be growing as they thought. However when I see a “fan chart” showing 3% economic growth at its centre I am unsure whether to laugh or cry. Even worse this was predicated on £200 billion of Quantitative Easing and we now have £375 billion of it which apparently according to ex-MPC member David Blanchflower is the “lifeblood” of our economy. So if they had put that into their equation they would perhaps be forecasting 4% economic growth right now. Ooops!
Rather interestingly if we look back from November 2010 we see that the fan chart tells us that the Bank of England forecasting record up to then was excellent as the actual GDP line is pretty much slap bang in the middle. An outstanding effort! Now if anyone can send me evidence that the Bank of England actually predicted an annual rate of fall of 6% in UK GDP for a while in 2009 I would be grateful. You see if you follow the advice of Kylie Minogue and “Step Back In Time” and look at the Inflation Report two years previous to 2009 aka February 2007 then you see a fan chart centering on 2.5% economic growth. That is +2.5% as opposed to -6% which some might think is quite a divergence.
It is of course possible that someone has placed fake Inflation Reports on the Bank of England’s website to embarrass them but then you hit the issue of why? After all they do a pretty good job of that if left to their own devices.
If we move onto inflation we see that the Bank of England was predicting that it would fall to 2% at the beginning of 2012 and then drift lower to approximately 1.6% now. It is of course 2.7% now. So above rather than below target which is an important nuance as I will discuss below.
Did the Bank of England do any better last year?
Let me keep with the theme of a famous Australian pop poppet and use her songs to demonstrate this. Now Mervyn if you are reading not this one.
I should be so lucky Lucky lucky lucky
You weren’t! No I meant this one.
I’m spinning around Move outta my way
You see Mervyn told us this.
Inflation fell back in October to 5.0%.
This is technically true as it had been 5.2% the month before but perhaps he will explain how it fell back from a forecast of below 2% to 5%.
But we have not even left the Governor’s opening statement and we have another glaring error.
Real take-home pay should gradually begin to recover after a period in which prices have grown faster than wages.
Yesterday we saw that CPI inflation is at 2.7% and RPI inflation is at 3.2% and today have been told this by the Office for National Statistics.
Total pay for employees in Great Britain rose by 1.8 per cent
Unless there is some alternate universe going on here where mathematical rules are different then we see that real wages continue to fall.
If we move onto the main detail we see yet again that the Bank of England’s forecasting record up to that point was superb! According to itself anyway! However this does not quite seem to tally with telling us that inflation would be about 1% now (more inaccurate than a year earlier) also it told us that we would have had 1% economic growth over the past year rather than none.
But never mind because according to it economic growth in the UK is just about to surge to over 3% by this time next year. It is time for a bit of Earth Wind and Fire I think.
Take a ride in the sky
On our ship fantasise
All your dreams will come true right away
I have in the course of today’s post said that I would explain why this mistakes matter. The answer is simple which is that UK monetary policy has been set according to these incorrect forecasts and so by definition it has been wrong. A clear example of this is the way that Quantitative Easing has been expanded to £375 billion in an attempt to boost inflation because the forecast has been for the level of inflation to be below the 2% target when in fact it has been above it continuously for nearly three years.
Also if we consider QE we keep being told that it boosts economic growth which might make you think that as we keep getting more of it economic growth would be going well. Instead it has done the reverse.
To my mind the choice that one has is between the Bank of England being actually incompetent – at which they are doing a convincing job- or whether these are deliberate errors as part of some unspecified policy.
Moving onto today’s effort let me give you some initial thoughts. Mervyn seems to have had a complete change of mind here.
output growth is likely to fall back sharply in Q4 as the boost from the Olympics in the summer is reversed – indeed output may shrink a little this quarter.
Although he does have a brief flash of self-analysis and hence insight.
It is difficult to discern the underlying picture.
Also Sir Humphrey Appleby’s critique applies here I think
This does not mean that the MPC is no longer in control of monetary policy.
For those who have not come across this before let me hand over to Sir Humphrey.
Never believe anything until it is officially denied