Bank can't afford to scare investors even more with the suggestion that it is relaxed about the government inflating away its debt

TO BE NOTED: From the BBC:

"Fears of deflation are not what they were

Post categories: Bank of England, QE

Stephanie Flanders | 15:46 UK time, Tuesday, 19 May 2009

Today's inflation figures confirm that it's not time to start worrying about inflation yet. But the subtext of last week's Inflation Report from the Bank of England [2.6Mb PDF] was that fears of deflation are not what they were.

At one level, that suggests that the Bank's policies are working. But it also underscores how challenging the next few years will be for our central bank.

As Liam Halligan has pointed out, the word "deflation" doesn't feature once in this latest Inflation Report. Looking back to the February report [2.9Mb PDF], I can find around half a dozen references, and a detailed explanation of what deflation could mean for the economy.

Of course, it was precisely that fear which led the Monetary Policy Committee to start its policy of quantitative easing (QE) the following month.

As Mervyn King emphasised in last week's press conference, the Bank thinks that it's too soon to judge the impact of that policy. But it clearly thinks that the combination of rate cuts and QE has helped to lower the risk of a sustained period of falling prices.

According to the latest Report, the MPC now thinks "there are significant risks to the inflation outlook in each direction". In February, it thought the the balance of risks "were slightly on the downside".

You can overdo the shift in the Bank's thinking. Remember how the governor went on (and on) about the degree of uncertainty.

Still, three months ago, it thought there was a less than 10% chance that CPI inflation would be above target in two years' time. Now (see Chart 5.7, p48) it thinks there's a roughly 20% chance of that happening, while the risk that inflation will be negative in two years' time has fallen, from about 1 in 4, to 1 in 10.

As I said when I first raised this point a few weeks ago, it's a long way from here to worrying about inflation. But, at the very least, the new forecasts suggest that there's less room for the economy to grow rapidly after 2010, without raising inflation, than we might have hoped.

It's also a reminder of the very fine line the Bank will be walking, if and when a self-sustaining recovery does arrive.

Mervyn King's fairly downbeat assessment of the economy last week helped to douse city speculation about how and when QE would be put into reverse.

However, the implication of the Bank's own report is that even with a fairly weak recovery, the MPC will be grappling with those questions sooner than you might think.

This is particularly important when one considers the UK's somewhat mixed standing in international markets.

Last week's grim economic news from the Eurozone economies reminded us that the UK has a big advantage in this crisis which those countries lack - the ability to print our own money (or to create it electronically, as we must learn to say).

As long as it doesn't cause inflation, QE should help boost demand and lessen the cost of the recession. But, as Mervyn King admitted last week, one of its direct - indeed, less intended - effects ought to be to push down the currency.

That is bad news for any foreigner sitting on British assets. The Bank can't afford to scare investors even more with the suggestion that it is relaxed about the government inflating away its debt.

Now, as it happens, sterling has gone up since QE began (and it rose again today). It just shows that the currency markets never do what they're supposed to do - though the pound is still far below where it was last summer.

The Bank's policy is only one factor affecting sterling. And if it's bringing the recovery closer, a lot of investors will consider that a plus for the pound.

Be in no doubt - if there is now a smaller risk of a long period of falling prices, that is extremely good news. With our high level of public and private debt, deflation would be a worse disaster for the UK than for almost any other major economy.

But we might pay a heavy price if investors start to think that the Bank is taking us too far the other way. "

In fact, we haven't seen a decline this rapid since comparable records began in 1955, and probably not since the Great Depression.

TO BE NOTED: From the BBC:

"Reversion to the extreme

Post categories: Budget

Stephanie Flanders | 12:19 UK time, Friday, 24 April 2009

Today's GDP figures confirm that this recession is already on a par with the downturn of the early 1980s, and quite possibly worse. Taken alongside the bad news on the public finances revealed in the Budget, this may go down as the week that defined Britain's political and economic choices for at least a decade.

Take the GDP numbers first. If this preliminary estimate is right, then the economy was 4.1% smaller at the end of March than it was 12 months earlier. That is worse than anything that happened in the early 1990s recession and equals the decline in the last quarter of 1980.

But the pace of the downturn - 3.5% down in the past six months alone - is actually worse than any equivalent period in the early 1980s. In fact, we haven't seen a decline this rapid since comparable records began in 1955, and probably not since the Great Depression.

This is a preliminary estimate, at an unusually difficult time. The estimates for growth in the production sector are based on data covering just the first two months of the year, and the basis for the service sector estimate is even patchier.

We know that several surveys in the past month or so have suggested that the pace of decline is slowing down. If that is true, this early estimate could be revised up, and the first quarter could mark the worst of the recession, as the CBI and others suggest.

But even if that were the case, we could still have many months of declining GDP to go. And there is nothing to stop the pace of the downturn from speeding back up.

The economy shrank by just 0.3% in the third quarter of 1980, after a 2.6% decline over the previous six months. Everyone thought that the worst was over, and it was. But the economy still shrank by another 1.7% in the two quarters after that.

To state the obvious, these figures make the government's forecast of negative growth of 3.5% in 2009 look very difficult to achieve. The borrowing figures already look set to be revised upwards yet again.

But here's the funny thing - as the nation's economic options have shrunk this week, our political landscape seems to have opened up.

Call it "reversion to the extreme". When the economy was booming, it was common to point out how small the differences between the main parties had become.

The realm of the economically possible during that period now looks positively luxurious: our debt level was fairly low, and stable, and tax revenues were pouring in. But back then, the room for manoeuvre from a political standpoint was perceived to be very small.

Take the 2005 election. On the economy, the great dividing line between the parties back then came down to a difference in spending plans of just £12bn. Yes, you did read that right. The Conservatives planned to increase public spending by £12bn less than Labour over the three years after the election, whereas the Liberal Democrats planned to spend about £12bn more.

That seemed a small number even then. In the week when this year's borrowing figure alone was revised up by £57bn, it sounds like an elaborate practical joke.

There are now no good economic options available to a British chancellor. Indeed, with borrowing at this level, there aren't many options at all. Yet listen to the politicians and you would think the opposite.

Suddenly, Labour seems to think it can win support by taxing the rich, after more than 15 years when it was convinced that any such talk would scare voters away.

Likewise, the Conservatives, privately at least, think that the sense of crisis is such that they will be able to pose hard spending choices to the electorate which would have been unthinkable even one year ago.

There's a lot of this story still to play out, on the economy, the budget and everything else. But already the political economy of Britain has been turned on its head."