For Britain, Inflation Was the Surprise in 2010

In economics, as in life, “it’s all relative” is a useful motto. Compared with most years, 2010 was pretty difficult, with unremarkable economic growth, record government borrowing and plenty of economic and financial turbulence.

Compared with 2009, however, and with the final few months of 2008, the past 12 months have been a breeze. The economy recovered, despite predictions from plenty of non-economists that it would not.

Though you would not think it now from the indiscretions of Liberal Democrat MPs and ministers, the coalition made a huge difference. Against market worries that a hung parliament would tip Britain over the precipice, guaranteeing the loss of the country’s AAA sovereign debt rating, the emergency budget in June and the comprehensive spending review in October succeeded remarkably in first stabilising then improving sentiment.

The Treasury under George Osborne is not an exciting organisation bristling with ideas. It has made errors, some of them easily avoidable. But it has taken a workmanlike attitude on its main priority – getting the budget deficit down – and investors have decided that this is non negotiable.

This chancellor will stand or fall, not on imaginative tax reforms, or on his ability to charm his political opponents and allies, but whether, at the end of this parliament, the budget deficit is no longer an issue. That is the goal, and that is how he will be judged. The benefit of the doubt from the markets comes in spite of the fact that recent numbers on the public finances have been disappointing, culminating in record net borrowing of £23.3 billion in November. Borrowing so far this fiscal year is down on the equivalent period in 2009-10 but only marginally so; £104.4 billion versus £105.1 billion.

What would have happened if Labour had won the election? Alistair Darling will give us his account soon (I have yet to see a copy of Gordon Brown’s book) but I would not be surprised if part of the narrative is about how he was as determined as anybody to get the deficit down but was continually frustrated by the then prime minister and his allies.

Certainly, senior officials at the Treasury had come to the conclusion that successful deficit-reduction would be impossible with Brown in charge. Mervyn King got into hot water for making a similar view a little too public.

The economy’s ability to grow through the cuts and the tax hikes is the big issue for 2011 and there will be a lot more on that next week. We started 2010, however, with plenty of people wondering whether there would be a recovery at all.

You may remember the kerfuffle over the Office for National Statistics’ initial stab at growth in the fourth quarter of 2009 – a mere 0.1% – immediately followed by the weather-affected first three months of this year, which some said would then be followed by election uncertainty.

Talk of a double-dip was rife, or the alternative of no recovery at all. In fact, that initial stab at the fourth quarter of 2009 was revised up again last week to 0.5%. And, despite some small downward revisions in the growth numbers for this year, the overall picture is of an economy that recovered well, particularly over the spring and summer. Over the past 12 months growth has been 2.7%. Calendar year growth for 2010 – this year’s gross domestic product compared with last year’s – looks like being 1.7%, though that depends on the current quarter.

Growth in the economy generated growth in jobs, up 219,000 over the latest 12 months, despite a small fall in the latest three months. There were those who thought we would pay for the smaller than expected jobless rise in 2009 with a big increase in 2010 but that, so far at least, has not been the case.

I will come of to my forecasting league table in a moment but this was a year when forecasters recovered their composure and a little bit of their pride.

Economists were a little too downbeat on growth at the start of the year, though not excessively so. Though some were not averse to a bit of double-dip headline-grabbing, the consensus forecast of 1.4% growth at the start of the year was close enough to the outturn to be respectable and certainly a vast improvement on the failure to hit the barn door of the recession in 2009.

Where forecasters did go wrong was on inflation. The consensus in January was that inflation would end the year just below the official 2% target, rather than stuck above it at 3.3%. Forecasters expected, as did the Bank of England, that the spare capacity left over by the recession would exert larger downward pressure on inflation than it did.

The persistent inflation overshoot is an embarrassment for the Bank and its forecasters. Most independent forecasters also failed to spot the danger, however. The two exceptions were Michael Saunders of Citigroup, a regular strong performer in my annual league table. He was a little too pessimistic, predicting 3.8% inflation by now.

The other, Brian Hilliard of Societe Generale, was spot on with 3.3%. He also did well with his other predictions, just edging this year’s forecaster of the year title from Saunders. You may think it strange that a French institution carried off the forecasting prize for Britain’s economy, though Hilliard is British and based in London.

You have to go a few steps down my league table for the first British name. After Societe Generale and Citigroup comes Bank of America/Merrill Lynch, BNP Paribas, the Daiwa Institute and J.P. Morgan. Only then do you get Peter Warburton of Economic Perspectives – last year’s top forecaster – and Lombard Stree Research.

I have taken recently to opening up the forecasting competition beyond the professional forecasters, with gratifying results. For the past few days I have felt rather like an exam marker. There were plenty of individual entries as well as some mass ones.

I am pleased to say that the amateur forecaster of the year was from one of the mass entries, from the King’s School, Canterbury. David Chan, a pupil, predicted 2% growth, 3% inflation, 1.35m unemployment and a £30 billion current account deficit. He blotted his copybook slightly with a prediction that Bank rate would be above 2% by now, but otherwise his effort scored a commendable eight out of 10.

Prizes will be on their way to him in the new year as they will be to the three runners up who each scored seven out of 10; Thomas Kyriakoudis, Chris Taylor and J.B. Blackamore. If I had some copies of that Gordon Brown book, I’d include them.

Overall, the standard was very good, with many others only just missing out on a high score. So I am happy to repeat the exercise for 2011. Will it be a year of reckoning, continuing unspectacular recovery, or a boom? Send in your entries.

My regular column is available to subscribers on – this is an excerpt. 

Originally published at David Smith’s EconomicsUK and reproduced here with permission.