The Short View

November 14, 2012 10:28 pm

Investors keep faith in BoE despite gloom

Stiff upper lip, old boy! Britain’s inflation is set to be higher for longer, real take-home pay has never been squeezed for so long, and output will not pass its 2008 high for another two years.

To leaven its latest gloomy forecasts, all Sir Mervyn King, Bank of England governor, could offer on Wednesday was to point out that at least pay rises were under control.

Depression-era stagnation and 1970s-style stagflation are often bandied about as comparisons. Both are overdone. Things are bad but not that bad.

A common measure of misery is unemployment plus inflation. On that basis, Britons are slightly worse off than the US and in far better shape than the eurozone.

Compared with the early 1990s, early 1980s or mid-1970s, though, these are not hard times. When I were a lad, as the Monty Python crew would say, the UK had the three-day week, a rescue by the International Monetary Fund and inflation which peaked at 26 per cent. As Kevin Gardiner at Barclays Wealth says, what we are living through now hardly compares.

Monetary policy, Sir Mervyn admits, can only spread out the pain of an “inevitable” adjustment.

Britons look longingly across the Atlantic at the US, where the economy is above its pre-crisis peak. But the UK grew faster beforehand, as households took on more debt; growth should be slower afterwards as households delever.

Take 10-year growth to smooth out the boom and the bust, and per capita GDP growth in the US and UK is pretty much the same.

Markets do not care how bad things feel or how much worse they were in the past. The pound dropped slightly on the BoE’s higher inflation forecast while 10-year gilt yields rose slightly. Yet bond markets remain unworried by inflation.

Market-implied “breakeven” inflation rates for the next five, 10 and 20 years are all well under control and below where they stood before 2008.

In spite of everything, investors retain a touching faith in the BoE.

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