Either way, after getting so wrong at the start of the cost of living crisis, the Bank of England may once again misjudge the outlook we find ourselves in. The error this time around has less to do with inflation and more with the focus on the economy’s downside potential.
Given the political hysteria around the current cost of living crisis, this is in some ways an understandable mistake. Everyone seems to be freaking out.
However, to restore lost credibility, it is essential that the Bank does not allow itself to be carried away by the latest wave of pessimism. As Savvas Savouri, chief economist at Toscafund Asset Management, pointed out in a recent note, the Bank’s latest forecasts are based on assumptions that are indeed quite suspect.
To begin with, the Bank assumes that energy and commodity prices will follow current market expectations for the next six months and then remain high in perpetuity thereafter. Even against the backdrop of European economies scrambling to wean themselves off Russian hydrocarbons, this seems extraordinarily unlikely and quite out of step with past experience of oil price spikes.
It is much more likely that with a rapid slowdown in economies, energy prices will fall quite significantly over the next couple of years. And in doing so, they will exert strong pressure on overall inflation rates, bringing wage and price growth back to the same level.
The assumption that fiscal policy will remain as it is now – implying no further relief from the cost of living crisis – also seems questionable.
Rishi Sunak, the chancellor, insists he will wait for the autumn budget, when the energy price trend should be clearer, before deciding whether to act. But unless he has a political death wish, he most certainly must act if energy prices stay where they are today. Such a stimulus would bring immediate relief to the economy.
Moreover, the Bank’s forecast is based on market expectations that the bank rate will reach 2.5% by the middle of next year. Yet even Bailey seems to suggest that this figure is too high given the current recessionary pressures on the UK economy.
In other words, there are all kinds of reasons to think that the forecasts are too pessimistic.