MNI INTERVIEW: 'Strange' Soft 2025 Growth Key To BOE Cut Case
MNI ((MNI) London) - MNI (LONDON) - The Bank of England's forecast for growth to slow over the next 12 months seems to contradict its assessment that the effect of previous policy tightening fed through quickly, raising questions over its room to further cut interest rates, the National Institute of Economic and Social Research’s Deputy Director Stephen Millard told MNI.
“If the tightening effects really did come through quicker then these effects are out of the way now. So it's even harder to explain the slowing down over the coming 12 months," Millard said in an interview. NIESR’s own forecasts imply the BOE is wrong, and that growth will not slow, while the Institute also has a lower estimate of the non-inflationary trend rate of growth than the Bank, both of which would argue against adding any more this year to the easing cycle begun earlier this month when Bank Rate was cut by 25 basis points on a 5-4 Monetary Policy Committee vote.
"The bottom line is a view about slack, and the two key elements of that are the medium-term equilibrium rate of unemployment, which the MPC ... have said they think is four and a half percent at the moment, and it's also a view about ... the long run rate of growth of the economy," where the MPC is at 1.5%, Millard said.
The MPC expects annual GDP growth to slow to 0.8% over the next year from the third quarter, he noted.
“It's because of that opening up of the output gap that they think inflation is well and truly on target now, and that's how they can afford to cut," he added. 'We think growth over the coming year is going to be 1.2% against trend rate of growth that's around about 1.1%. So in the NIESR forecasts ... You actually have excess demand.”
The BOE’s downbeat growth assessment came despite its inclusion of a box in its August Monetary Policy Report arguing that the effects of policy tightening had come through faster than assumed, in part because of structural changes in the gilt market (See MNI INTERVIEW: Fast Rates Transmission Argues For BOE Caution).
"That's quite strange ... that goes against their forecast,” said Millard.
LONG HAUL FOR BERNANKE REFORMS
The Bank’s economic forecasts came under scrutiny following its failure to predict the full extent of the recent surge in inflation, prompting it to commission a report by former Federal Reserve chief Ben Bernanke, who recommended changes including the development of alternative scenarios. But Millard, previously a senior BOE official, said most of this will be slow work, though the Bank could make some of the simpler recommended changes more quickly, such as shortening its policy statements and spelling out previous forecast errors.
Rebuilding "the infrastructure, the IT software, data management, all that kind of thing that will take time. What could be done a little bit more quickly, if they wanted to, would be some of the recommendations around communication of the risks and uncertainties." he said
The August MPR only had what the Bank called “a proto-type” alternative scenario showing more persistent inflation.
"In the heat of the forecast round, you're working pretty hard as it is, to then have to spend a lot of time on scenario analysis would really be difficult. So to be able to do it [scenario analysis] in a timely manner you do first need to look and work through the infrastructure issues," he said.
It took the BOE around a year to introduce its core model, COMPASS, and the more ambitious Bernanke reforms are likely to be more challenging, Millard noted.
(Additional reporting by Harrison Moore)