The reality may be worse than the forecast
ANALYSIS:The Central Bank’s forecast merely signs up publicly the established consensus
TO BE perfectly frank, there is scant increment of information or insight in yesterday’s assessment of the economy from the Central Bank.
It is very much a case of Dame Street signing up publicly to what has lately become the consensus among forecasters, namely that national output will decline by between 4 and 5 per cent this year, that total employment will fall at a broadly similar rate, that unemployment will increase towards 10 per cent, that the inflation rate will turn negative, and that the Government’s budget deficit will be getting on for €17 billion-€18 billion.
I know from personal experience that short-term economic forecasts rarely start with a blank page. Even when the context is changing with bewildering speed, as at the moment, there are two sets of numbers to which the short-term forecaster pays particular attention. The first is his/her last set of forecasts and the second is the latest forecasts from others in the field.
In general, it’s not held to be a good idea to change one’s forecasts too much, especially if the last set was published, as is generally the case, only three months previously. But it’s regarded as even less of a good idea to produce a set of forecasts that is radically different from those recently published by others.
The risk to which most practitioners of the art are most averse is that of being wrong and alone. In this respect, government-sponsored forecasters are especially risk averse.
One result of this kind of herd behaviour is that most forecasters make the same mistakes by overlooking the same information, underestimating the same risks, subscribing to the same poorly grounded assumption or whatever. So, more often than not, the forecasts are wide of the mark, even when they represent what’s called a consensus. Therefore, it pays to ask the question: if the actuality proves to be different from the forecast, is it more likely to be materially worse than materially better? My own fear is that this time it will be materially worse.
Let’s take exports as a case in point. The bank now expects the volume of exports to decline by 0.7 per cent this year, down from the 2.2 per cent increase it was expecting last October. (By the way, this is almost identical to the latest forecasts from the ESRI and the Department of Finance which are -0.4 per cent and -0.5 per cent respectively.) The downward revision here looks modest when set against the changes that the bank has made to the key assumptions that underpin the export numbers. As of October, the bank expected GDP growth of 1-1.5 per cent in our main trading partners in 2009 and an average sterling/euro rate of 0.80 for the year; its latest assessment is based on GDP declines of about 1 per cent in the US and Britain together with a 0.6 per cent increase in the euro area and, crucially, an average sterling/euro rate of 0.95.
To prevent export volumes declining by more than 0.7 per cent in such circumstances would, I think, be an incredible feat, particularly given the likelihood of a steep decline in financial services exports because of the implosion of the global financial system.
But there’s more: the assessment of international economic conditions on which the bank’s forecasts are based is several months out of date – it is actually the OECD’s Economic Outlook of last November. The most recent IMF World Economic Outlook, published on Tuesday, sets out a much gloomier picture: it sees GDP declining by 1.6 per cent in the US, 2 per cent in the euro area and almost 3 per cent in Britain in 2009.
One area where the probability of forecasting error yields somewhat better news is inflation. The bank is now forecasting an average CPI inflation rate of -1.9 per cent for the year, compared with +1.9 per cent in its last bulletin. This is in line with the emerging consensus, but still much too cautious in my view.
Excluding mortgage costs (in other words, on a HICP basis), the forecast is for a small rise of 0.3 per cent. I don’t think this will materialise. Recently, the HICP has been falling month-by-month, as energy prices have come down, import prices have responded to an appreciating currency and retailers have been forced to cut their margins by the new realities of the marketplace.
In summary: output is likely to be a good deal weaker in 2009 than the Central Bank (and others) envisage; so too is the price level. The latter is good news because it will help us, via its influence on wages and salaries, to regain lost competitiveness more quickly than would otherwise be the case.