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Wednesday, 8 August 2012

BoE: UK growth unusually uncertain due to eurozone

In its Inflation Report released today, the Bank of England (BoE) states that "The outlook for UK growth remains unusually uncertain".

Below are some of the key points from the report:

"The greatest threat to the recovery stems from the risk that an effective policy response is not implemented sufficiently promptly in the euro area to ensure that the adjustments in the level of debt and competitiveness required by some member countries occur in an orderly manner. Even if an effective set of policies is implemented, the scale of the necessary adjustments points to a sustained period of sluggish euro-area growth and heightened uncertainty". 

BoE explains further,

"As in past Reports, the MPC sees no meaningful way to quantify the size and likelihood of the most extreme possibilities associated with developments in the euro area, and they are therefore excluded from the fan charts. But the threat of these more extreme outcomes is likely to continue to weigh on UK economic activity over the forecast period, for example through its effect on asset prices and confidence".

And finally,

"There remains a range of views among Committee members about the outlook for GDP growth. On the above assumptions, the Committee’s best collective judgement is that the economy will gradually recover, but that GDP growth in the second half of the forecast period is more likely to be below than above its historical average rate. That outlook is weaker than in the May Report reflecting the possibility that the factors contributing to the weakness of growth since the financial crisis may persist. The difficulty of knowing for how long these factors will continue has caused the Committee to widen the GDP fan chart".
The BoE in the report explains that "The level of output is not likely to surpass its pre-crisis level until 2014" and on inflation (CPI) "On balance, the Committee’s best collective judgement, based on the conditioning assumptions described above, is that inflation is a little more likely to be below than above the 2% target for much of the second half of the forecast period, but those risks
The Bank of England clearly seems concerned and uncertain about the outlook both in the UK and the eurozone. It is interesting to note that it has excluded "the most extreme possibilities associated with developments in the euro area" from the fan charts. As all their fan charts portray a wide range of possibilities, we assume these extreme possibilities related to the euro zone were excluded as to avoid having to formally recognise them in their model and hence to avoid head lines in the press. By ommitting these potentially extreme outcomes, the BoE has in effect rendered their models useless (or more useless, as most models regarding the future are). Therefore, do not rely on their forecasts for investment purposes and whatever you do, make sure to incorporate the worst possible outcomes as well in your model.

To read all the reports, visit the BoE website. Alternatively, just read the Overview. Here are some of the published charts included in the Inflation Report.