Economic outlook. Boringly benign

Date: 18/02/06

But there are risks to the Bank's main forecasts

MERVYN KING, the governor of the Bank of England, has long desired to take the drama out of monetary policy. Judging by the Bank's latest Inflation Report, he is close to fulfilling his ambition. The only sensation in the quarterly outlook was how stunningly stable the economy will be as it picks up speed over the next couple of years.

According to the Bank, last year's slowdown, when GDP grew by only 1.8%, will soon seem a distant memory. By the end of the year, GDP is forecast to be rising by an above-trend 3% a year, a pace sustained through 2007. Yet the central projection for consumer-price inflation shows it glued to the government's target of 2% a year.

The Bank's projections are based on market expectations of interest rates, which are broadly flat over the next couple of years. The report thus implies that the base rate is, boringly, likely to remain at 4.5%, where it has been held since last August's evidently over-sensational quarter-point cut from 4.75%.

The outlook appears so tediously benign it verges upon the panglossian. No doubt that was why Mr King was keen to highlight the risks when presenting the report on February 15th. These are on the downside for growth, he said, but "evenly balanced" for inflation.

The central growth forecast certainly looks quite punchy, although the Bank has in fact lowered it a bit for 2007 since it last ventured a prediction in November. Much depends upon the consumer, whose reluctance to spend last year pulled GDP growth down. The Bank now expects household spending to grow by close to its long-term average over the next three years. This could prove too optimistic, now that the housing market has become much less frothy and people are being urged to save more for their retirement.

If growth is lower than expected--and the Bank concedes that consumer spending could turn out to be weaker than in its central projection--the effect will be to pull down inflation. But set against this are possible risks that could push inflation up, notably the longer-term impact of higher energy prices.

The evidence so far is encouraging. In marked contrast with previous oil-price shocks, the sharp jump in fuel bills has not fed through to big wage demands. Official figures released on February 15th showed that pay growth remains well under control. Average earnings, excluding bonuses, rose by 3.8% in the year to the final quarter of 2005.

One reason why pay pressures have been tame is the influx of new migrant workers from eastern Europe. Nearly 300,000 registered for work between May 2004 and September 2005. This has pushed the growth of the working-age population up to its highest rate in over 20 years. A survey by the Bank shows that overseas workers are particularly prominent in agriculture, and hotels and restaurants (see chart). In both sectors, this appears to have restrained pay.

Higher inflows of migrants may have eased capacity constraints, but it is uncertain whether the influx will continue, especially now that jobs are becoming scarcer. Furthermore, productivity growth has collapsed in the past year, arousing fears that the underlying growth in capacity may have slowed. The risks to the Bank's rosy forecasts may well lie as much with constraints on the supply side of the economy as with shocks to demand.