The Bank of England Inflation Report (May) was released this week. The Bank down graded the forecast for growth in the current year to 1.8% with above trend growth likely in 2012. I am now more optimistic* than the Bank of England which is depressing. Unless there is some surprise in the Q2 GDP figures to be released in July, we will make a further down grade towards the consensus 1.7% for UK GDP growth in the QE3 review in August.
The Bank thinks that inflation is likely to rise to 5% this year before magically falling back to the 2% target. As the Bank explains, CPI inflation is likely to rise further this year, following additional increases in energy and import prices. In the medium term, “the chances of inflation being above or below the target are judged to be about the same”.
Inflation is expected to fall back during 2012, as the effects of high energy, import prices and the recent rise in VAT fall out of the index. Downward pressure from spare capacity will also bear down on inflation according to the Bank.
What is never clearly explained is that CPI service sector inflation has averaged 3.6% for the last twenty years. The 2% target has only been possible by extremely low goods inflation. Given recent changes in China and Asia, cheap manufactured goods may no longer be feasible in the years ahead. Let's not forget that manufacturing prices increased by over 5% in April.
As for growth, the Bank says “underlying growth has moderated in recent quarters, but it is unclear whether that slowdown is temporary or will be prolonged. The continued global recovery, the considerable stimulus from monetary policy and the past depreciation of sterling should all help to support growth”.
The continuing squeeze on households’ real incomes is likely to weigh on demand, especially over the next year or so but the Bank makes light reference to the impact of a tight fiscal policy equivalent to almost 1.5% of GDP.
Growth is expected to slow further in the second quarter before returning to trend 2.5% approximately in the final quarter. In the years ahead, inflation will return to target and growth will be above trend. It will all turn out OK. Sleeping Beauty will buy a Silentnight bed without a pension liability and Miss Haversham will finally get married. The End.
*The pro.manchester Economics Review is available as a down load here.
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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.