Mervyn King's announcement that “the Nice decade” is over was not quite what it seemed. The Governor actually made the same forecast four years ago in an interview with The Times, immediately after his first appointment to run the Bank of England. His adjective “nice” was intended less as a value judgment than a succinct statistical description of the past ten years or so. In terms of economic figures, it is an undeniable fact that the 15 years since Britain was expelled from the European exchange-rate mechanism has been an unprecedented period of “Non-Inflationary Continuous Expansion”. Hence the acronym “Nice”.

More important than such semantic curiosities are the economic implications of Mr King's remark. The implication most in the news last week was that interest-rate reductions were now off the agenda because of escalating inflation. Yet this is far from clear. The Bank predicted in last week's Inflation Report that the official CPI inflation measure, which has just hit 3 per cent, would rise further and stay stubbornly high for some time. As a result, not one but several letters of explanation to the Chancellor would have to be written by Mr King.

It is far from clear, however, that this inflation overshoot would, on its own, preclude further rate cuts. The Monetary Policy Committee knows better than anyone that whatever interest-rate actions it takes this year will have no effect on inflation until the second half of 2009 and beyond. Inflation figures will, therefore, drive MPC decisions only to the extent that they affect public expectations of future price increases - and particularly wage settlements that might threaten to lock in higher inflation as a permanent fact of life.

These settlements, in turn, will depend on the strength of economic activity and employment and on the attitude of the Treasury to pay settlements in the public sector.

From this standpoint, the real reason to worry about high interest rates last week came not from the Bank, but from Gordon Brown. His willingness to tear up the Treasury's Budget and his fiscal rules in order to stave off a backbench revolt suggests that similar concessions can be expected in the face of union and pensioner demands for compensation against higher prices. If last week's tax climbdown turns out to be the start of abandonment of budgetary discipline by government, the Bank will have to keep monetary policy very tight to prevent high inflation becoming once again a permanent feature of Britain's economic life.

Assuming, however, that the Government does manage to avoid a 1970s-style public sector wage-price spiral, the second aspect of the end of the Nice decade - the part about continuous expansion - will assume increasing prominence in the months ahead. A drastic slowdown in consumer spending and a further sharp fall in house prices now looks inevitable. This means that the Bank probably will cut interest rates much more than expected between now and the year-end, provided that a wage-price spiral does not intervene.

In many ways, today's economic situation in Britain - and the rest of Europe - is similar to America a year ago, after house prices had begun falling and consumer spending had begun slowing but before the economic slowdown's extent had become clear. A year ago, the Federal Reserve was as preoccupied with inflation and as determined to avoid drastic rate cuts as the Bank of England and the European Central Bank are today. The reluctance to ease monetary policy in the United States a year ago was understandable, just as it is in Britain and Europe now. After all, economic statistics in Britain and Europe do not yet show clear signs of a severe economic slowdown. And the Bank expects significant support for the British economy from exports, given how far the pound has already fallen - and how much more it could easily fall in the months ahead.

On the face of it, this optimism makes some sense. After all, the German economy grew at an annualised rate of more than 6 per cent in the first quarter, its fastest growth since the reunification boom of the early 1990s, according to last week's preliminary statistics. So why shouldn't Britain also enjoy some Germanic export-led growth, especially with the pound at its lowest against the euro since 1995? One obvious reason is that Britain has far fewer competitive export companies than Germany and expanding the manufacturing sector to take advantage of a lower exchange rate will take many years, if not decades. This may not, in fact, be quite as big an impediment as is often assumed, since Britain's manufacturing sector is actually about the same size relative to the economy as in the US and France.

There is, though, a more immediate reason for Britain not to count on Germanic economic expansion in the year ahead: the recent growth spurt reported in Germany (and the rest of Europe) is probably an illusion. There are at least three reasons not to pay too much attention to what excitable economists and politicians in Germany hailed as sensational data.

First, all German economic figures are notoriously volatile and prone to huge revisions. Possibly because of excessive deference for anything with an official-looking seal of approval, German statisticians tend to take preliminary reports from ministries at face value, rather than smoothing or excluding apparent aberrations. So, German statistics lurch like a drunken sailor, in contrast to US or British statistics, which show more consistent trends. A second reason for scepticism about the strength of growth in Europe has been the mild winter in Germany. This resulted in a big, but strictly temporary, boost to construction activity on a seasonally adjusted basis. This is now being reversed. These were the technical reasons why Jean-Claude Trichet poured cold water on celebrations, giving warning that second-quarter growth would be “less flattering”.

Finally, there is worrying similarity with America a year ago. A quarter or two of aberrantly strong growth often precedes a recession or sharp cyclical slowdown - especially when, as appears to have been so in Germany last quarter, the main engine of growth has been capital investment, including an inventory build-up. In this sense, the position in Germany is ominously reminiscent of US performance in the third quarter of 2007, when GDP rose at its fastest since 2003. America's sudden growth spurt last summer was followed by a severe slowdown. A very similar pattern is now likely in Europe. I have suggested repeatedly that Europe and Britain have been following the same boom-bust roadmap as the US, but with a lag of 12 months. Last week's strong German figures were perfectly consistent with this view.

The chances are that Britain and Europe will slow drastically in the months ahead, just as America did a year ago. Once this slowdown becomes apparent, the Bank and the ECB will start to cut interest rates, just as the Fed did last year. Nobody can say for sure whether the slowdown in Europe and Britain will be deeper or shallower than the one in America. But to judge by the US experience, it will be at least two years before Britain can dream about another Nice decade.

anatole.kaletsky@thetimes.co.uk

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