NEVER one to pass up the opportunity of employing a useful cliché, I have lost
count of the times I have used “a year of two halves” to describe the
preceding 12 months. But now, just when I have worn it out, the expression
seems more apt than ever.
Cast your mind back to the first half of the year, and the exuberance was
tangible. Every day, it seemed, there was a new private-equity deal. The
economy was booming and so were house prices. The governor of the Bank of
England was forced to write an open letter explaining why inflation had
risen above 3%. He and the rest of the monetary policy committee (MPC),
desperate to control this bucking bronco of an economy, raised interest
rates from 4.5% to 5.75% and promised more. The last of those increases
came, appropriately enough, in early July, just after the middle of the year.
Then the wind changed. It was not quite a Michael Fish moment for King, but
his insistence on August 8 that there was no international financial crisis
was followed on August 9 by the equivalent of a hurricane in the money
markets.
Since then, of course, it has been a question of watching and waiting. Most of
the economic data, it should be said, have continued on the strong side,
including perky figures for November retail sales on both sides of the
Atlantic. But the surveys have suggested weaker growth ahead and so has a
sharp drop in business and consumer confidence. The housing market has been
notably weak and appears to have felt the impact of the credit crunch most
intensely, coupled as it was with the introduction of home information packs
(Hips).
At first it seemed as though the eye of the storm had passed quickly, and
money markets began to return to normal in October. But a second gust
followed, to which central banks were obliged to respond.
So who got the economy right? The answer, in important respects, is nobody.
There were people who worried about losses on sub-prime lending in the
United States. There were those who were concerned that the Bank and other
central banks were raising rates more than was necessary. I drew the line at
the last of the MPC’s rate hikes.
But nobody, to my knowledge, predicted that the sub-prime crisis would spread
as it did, forcing central banks into unprecedented action to support the
markets, forcing some of them to reverse previous rate rises and forcing
Northern Rock into the unwilling arms of the Bank of England. The story of
the economy in 2007 was not in the numbers but in the drama of real-life
events.
In terms of the numbers, forecasters were too downbeat about Britain’s growth
prospects this year, something to bear in mind perhaps when assessing some
of the direr warnings for 2008. Economists did better on inflation,
predicting it would get back to 2%, having been above it.
Even so, the consensus was that the Bank would not have to raise rates as much
as it did. Most Bank rate forecasts for the year-end were clustered around
5%. Unemployment was expected to rise rather than fall.
The recent bombshell announcement from the Office for National Statistics that
the current-account deficit in the third quarter was £20 billion also ruined
quite a few forecasts. Although the numbers will probably be revised, it is
hard at present to come up with a number of less than £60 billion for the
full-year deficit for 2007. That is a lot of red ink, roughly double the
average forecast made at the beginning of the year.
It is an ill wind, however, that blows nobody any good. The only economist who
got close to my guess for what would happen to the balance of payments
deficit was Michael Saunders of Citi, who predicted £56.9 billion.
Saunders, a previous winner of my annual forecasting competition, was also
more optimistic than most on growth (2.9%), close on inflation (2%), and
predicted a fourth-quarter Bank rate average of 5.4%. The only one he got
wrong was unemployment. But a score of 9 out of 10 was a very creditable
performance, and he deservedly tops the table again.
Speaking of 2008, he said recently: “The UK has probably been the fastest
growing country in the G7 this year but is likely to have the sharpest
slowdown among G7 countries in 2008.”
Congratulations also to Peter Spencer at the Ernst & Young Item Club, and
to JP Morgan and the others who got close.
How did I do? I was a little too low on growth, 2.6%, and thus too high on
unemployment, 1m; okay on inflation, 2%, but my prediction of a £40 billion
current-account deficit was not gloomy enough. I suggested Bank rate might
rise and fall, but to 5.5% and 5% respectively. I would have scored seven
out of 10.
I am always accused of being too optimistic about house prices, but this year,
as for the past couple of years, the rise exceeded my expectations,
certainly in the early part of the year. I thought house prices would rise
5% in 2007 as a whole, with most of the strength concentrated in the first
half. That will not be too far out but is probably still a little on the low
side.
In looking at the forecasting record for 2007, however, I also have to give a
large bouquet to the Treasury. It can never get top marks in my forecasting
league table because it does not make predictions of interest rates (because
this would be seen as second-guessing the Bank) or unemployment (because it
could be politically difficult openly to predict a rise).
But in a year when every independent forecaster was too gloomy about growth,
the Treasury’s optimism came good, having the only forecast (2.75% to 3.25%)
with a three in front of it. By sticking with its convention of predicting
that inflation will always gravitate towards the government’s 2% target, the
Treasury got that one right, too.
For 2008 the Treasury is expecting 2% to 2.5% growth and, as before, 2%
inflation, on the optimistic side of the consensus. Let us see if its luck
lasts. More next week on the 2008 outlook and the chances of a Bank rate cut
in January.
PS: I hope that those who have not already done so are
beavering away on the Christmas quiz, published here last week, and
available online for those who missed it. In the meantime, let me offer you
an end-of-year insight into the most popular subjects in this column, as
defined by the response from readers.
I have hinted before that readers can be relied on to reply robustly on a
range of subjects. Some appear a little taken aback when I respond in
similar vein. One of my frustrations is not always being able to respond to
the strange criticisms that sometimes appear out there in the zany world of
the internet.
Anyway, here are my top 10 reader-response subjects for 2007. 1. House
prices – no surprise there. After a period of hibernation, the bears have
wandered out of the woods again. 2. Gordon Brown’s economic record. 3.
Inflation, and whether you can believe the official figures. 4. Immigration
and the economy. 5. The Bank of England and whether it is (a) ignoring the
pain out there in the real economy or (b) ignoring its duty to keep
inflation under control. 6. Tax and, over the past few weeks, Alistair
Darling’s capital-gains-tax reforms. 7. The rise of China and India. 8.
Northern Rock. 9. Britain’s gaping trade gap, what it might mean for the
pound and the decline of UK manufacturing. 10. Oil prices and “peak” oil.
Keep the responses coming.
david.smith@sunday-times.co.uk
