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The Bank of England shows us what we could have won

Ben Chu

jimandbullys 150x150 The Bank of England shows us what we could have won

"Can't beat a bit of Bully!"

Jim Bowen of Bullseye (right) used to torment failed contestants on the darts-based gameshow with the words “let’s take a look at what you could have won” before unveiling a car, or a barbecue, or whatever.

The Bank of England struck me as rather Bowenesque in its latest Inflation Report.

It highlighted a choice of growth scenarios.

The first was what would happen to GDP if short-term interest rates moved in the manner predicted by traders in the money markets.

The second was what would happen if short-term rates remained constant at 0.5 per cent over the forecast period.

There was a strikingly stronger growth profile under the constant rates scenario as this (using the Bank’s central case mean average figures) shows:

GDP growth rate under Banks market and constatn rate scenarios2 The Bank of England shows us what we could have won

What this implies is that, in the Bank’s view, rising interest rates will make the recovery weaker than it otherwise would have been.

No great surprise, perhaps.

But what does that all mean for the level of GDP, and the question of when we can expect to get back to where we were before the great recession began?

This chart, which I’ve put together using Office for National Statistics historic GDP data and the Bank’s projections, answers the question:

GDP level1 The Bank of England shows us what we could have won

So under both the markets and constant rates scenario we’re set to regain the Q1 2008 peak in output in Q3 2014 (circled).

But over the forecast period a gap opens up by Q4 2016 so the economy is around 1 per cent smaller under the market rates scenario than if the Bank holds the base rate constant over that period.

The Governor, Mark Carney, drew attention to this divergence in the level of GDP in his opening remarks at the press conference.

So what’s going on?

Well, like Jim Bowen, the Old Lady of Threadneedle Street is showing us what we could have won if the financial markets had taken its “lower for longer” message on rates (also known as Forward Guidance) more fully to heart.

But (fond as I am of my Bullseye metaphor) I have to admit that the constant rate forecast is not just there to torment us.

The Bank is emphasising what Britain could still win if it decides to keep rates on hold after unemployment falls to the 7 per cent Forward Guidance threshold, which it presently expects to occur in Q3 2015 based on its market rates forecast and Q4 2014 on its constant rates forecast.

This is all possible, by the way, because in both scenarios the Bank thinks inflation will be close to the 2% target at the end of the forecast period: stronger growth does not lead to significantly higher inflation.

But does 1 per cent really matter in the scheme of things?

Mr Carney’s predecessor, Mervyn King, used to say that it’s the level of GDP rather than the growth rate that we should be focusing on.

And we’ve just experienced the weakest recovery from recession since records began.

In that context, surely every little helps.

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  • greggf

    “…..the Old Lady of Threadneedle Street is showing us what we could have won if the financial markets had taken its “lower for longer” message on rates….”

    So who, or what, determines interest rates then Ben?

    It seems to be the Bond markets.

    Buttonwood in the Economist (24 Mar 2012, ref; node/21551070) claims the developed world may have seen the low in bond yields, and concomitantly interest rates. It says a 30-year low occurred in July 2011, and recently the US Treasury sold $13 billion of 10-year inflation-protected securities at the highest yield since that month in 2011.

    Jim Bowen could still be a torment by pointing out what you could have had if you’d sold your ten-year Bonds last year, or in 2011…..


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