I’ve been wondering how the boffins over at the Bank of England were going to get out of the pickle they’re in. But lo and behold, they’ve come up with a fabulous wheeze.
You remember the problem: they’ve been forecasting miracle growth and a ‘V-shaped’ recovery in the hope that they’ll get one. But of course, as reality bites, they’ve got to downgrade this rosy outlook without looking like prize chumps.
Here’s how they’re going to pull it off.
Tucked away in the ‘notes to the accounts’, last week they announced that they’re building a new forecasting model at a cost of £2.4m. Why? Because the old machine just isn’t working; it’s been spitting out forecasts that are wrong – way too bullish in fact.
This is brilliant. Now they’ve got two free gos to downgrade their forecasts. First, now that they’ve admitted their forecasts are wrong, they’ve downgraded them (more about that in a minute). And secondly, when they’ve put in their £2.4m ‘fix’, they’ll be able to adjust them down again.
What is the Bank of England trying to hide? Well, it’s not pretty. In fact, it’s pretty grim. But there are a few ways you can protect yourself. And that’s what I want to tell you about today.
Why the Bank’s forecasts are complete junk
For the Bank’s forecasting model to cost so much just to repair it, you can tell that it’s quite a complicated ‘black box’. With these models, you basically plug in a load of economic data and a clever computer program crunches the numbers and throws out a forecast.
The problem is that if you put junk in, you get junk out.
The Bank’s model totally ignores what’s been going on in the banking system. It takes no account of the fact that banks practically collapsed; that ‘data set’ isn’t part of the input. Yet we all know that this recession came about from a banking crisis.
So here we are, we’re looking at the most important forecasting model in the UK and it takes no account of what’s probably the gravest factor affecting our economy. That is, are the banks willing and able to lend?
All the model does is look at past data to see what happens in a normal recession; but this is far from a normal recession. A fact the Bank is only beginning to recognise.
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The Bank wakes up to reality
You may have seen the Bank of England’s pretty green fan chart before. The fan gives a range of projections of where they reckon the economy’s going. The thick black line shows where we’ve been and, as you can see, we have indeed bounced out of a deep recession (well, we’re out for the moment anyway).
Back in May (their last forecast) I predicted that they’d have to shift that whole green fan downwards. And that’s exactly what’s happened.
At the time, they had growth heading back to 3.4% and barely acknowledged the possibility of a double dip – that is where the economy falls back into recession after a false recovery.
But if you look at the chart now, you can see that the bottom of their range hits some negative territory – that is back into a double dip recession.
Bank of England forecast for economic growth
Source: Bank of England
Halleluiah! At last we’re getting somewhere. Some recognition at least that things may take a turn for the worse.
But here’s the rub. I’m betting that come the next inflation report (in November), that green fan will get shifted down again. After all, the forecast has to take account of reality as reality arrives.
The grim truth behind these forecasts
Now here’s the secret that not many people know about: the Bank’s forecast tells us where they want the economy to go, not where the economy is likely to go. The bank is desperately hoping that the economy can get back to growing at between 2% and 4%, so this is what they put in their nice chart.
Once they’ve charted their hopes and dreams, they slap on a title that includes the word ‘forecast’ in it. But read in between the lines and you’ll see that they don’t really believe their so-called forecast.
Mervyn, the governor of the Bank is much more pessimistic than this forecast says he should be. He says that he’s open to using more quantitative easing (QE) – basically, flooding the financial system with money – if necessary.
Now that’s bold. QE goes against everything that a central banker knows to be right and proper. If there were a golden rule for central bankers, it would surely go along these lines: “Don’t print money. In fact, don’t even talk about printing money unless you’re absolutely desperate.”
The governor is desperate and he’s broken the cardinal rule.
The best way to play a dull economy
We’ve been here before of course. As you probably know by now, I’m not a big fan of the UK economy.
My advice is to stay cautious. Cash and bonds aren’t as bad as they appear at first sight. I think deflating asset markets are a bigger concern for investments than inflation is to cash.
As I mentioned last week, emerging markets remain in the ascendency. Remember, markets go in cycles and right now the emerging markets are in a different (and more exciting) stage of the cycle to much of the West.
The risk is that if financial markets turn down, then they’ll all go down together – including the emerging markets. Well, maybe so, but I’m building a portfolio for the long-run, and over the long-run, I expect the emerging markets to have the more interesting opportunities.
Last week I recommended an investment trust that could be a good bet for the emerging markets. On Wednesday, I’ll give you some details on how to use ETFs (exchange tracker funds) as an affordable way of getting into emerging markets.
• This article was first published in the free investment email The Right side.
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