Central banks don't set rates based on hard facts

LONDON BRIEFING/Chris Johns: The signs of recession are everywhere. In London, at least, all of the old-fashioned indicators of a slowdown can be observed. Taxis are plentiful and their drivers willing to take you anywhere - even south of the river - and are extremely polite.

Restaurant reservations are easy to get and it is possible to get served in bars in less than the usual 20 minutes. The property market is not yet in freefall but nobody is buying. Traffic is noticeable by its absence.

It is possible to get from the City of London to the West End, at peak times, in less than 15 minutes - something of a record. Either Ken Livingstone's congestion charge is working or something is seriously awry.

Of course, all of this is very anecdotal. While some of the more official statistics are suggesting one or two problems for the economy, they have not yet indicated full-blown recession. But they never do - until much after the event. Lags in the collection and dissemination of accurate economic data mean that we only ever really know the state of the economy from the perspective of a rear-view mirror.

And even then the picture is subject to revision. There is an old story about a sterling crisis and subsequent resignation of the then chancellor, all prompted by a balance of payments deficit that was later revised to a surplus when the statisticians stumbled across some hitherto undiscovered exports. Such is the state of official knowledge about the current condition of the economy.

Anybody who thinks that the Bank of England - or any other central bank - is setting interest rates with certain knowledge of where the economy is, let alone where it is going, is seriously kidding themselves.

Imagine steering a large boat through some dangerous reefs, unable to see anything in front of you while the only information is supplied by your crew, all of whom have different opinions about where you had been 20 minutes ago and are completely mute on your current position.

Hence, anecdotal evidence and its interpretation, while more art than science, is vitally important for the setting of interest rates. Indeed, such evidence is important for all sorts of economic and business planning. But it is only part of the story of course.

There is an even more difficult stage of the process, and it's called forecasting. Even if we can take a stab at the current position of the economy, that is of no help if it is about to change course.

If I'm right, and the UK economy hit a wall during February, then there is an obvious culprit.

Impending war with Iraq has prompted companies to postpone investment and consumers to stay in front of the TV. All of this is not restricted to the UK of course. There is plenty of similar evidence, including some official statistics as well as the anecdotal stories (anybody got on a plane recently?), from around the world. Europe has almost certainly "double-dipped" back into recession and the US is not far behind.

If we can blame all of this on war, then it might be natural to assume that the war's end, when it eventually arrives, will bring about an end to economic difficulties. All of that postponed spending by businesses and consumers can get under way, with no help needed from central banks or governments. However, there are two problems with this line of thinking.

First, much of the current economic weakness seen around the world may have happened anyway. There are lots of reasons for this but it was becoming extremely difficult to spot the obvious sources of economic growth over the next year or so.

The main driver of global growth - US and UK consumers - were beginning to look more than a little spent out and there is not much else that we can rely on to replace that source of demand once it rolls over. The thought of a spontaneous revival in European consumer spending or capital investment is rapidly becoming a sad joke.

The second problem relates to "postponed" spending. It won't take much more of this to turn that into "cancelled".

By contrast, both the Bank of England and the European Central Bank seem to think that much of the current slowdown is temporary and will cure itself once the war is over. I think they are making a dangerous mistake. Even if there is a relief rally in consumer and business confidence surveys - and equity markets - there will still be plenty of reasons for central banks to stay on their guard.

• Chris Johns is chief strategist with ABN Amro Securities, London. All opinions expressed are entirely personal.