Bank of England gets it right - Threat of UK deflation diminishes as concerns mount in Eurozone

Prompt action by the Bank of England means that the UK appears to have seen off the threat of deflation.  By contrast, Eurozone businesses are saying that deflation is a real risk, meaning that many continental economies will face a real struggle ahead. That’s according to the latest Eurozone Business Trends report from accountants and business advisors BDO.

Modest growth in the BDO Optimism index which measures medium term business confidence suggests that the recession has troughed in the UK and Eurozone and that the pace of recession will diminish in Q2 2009. The UK Optimism index rose from 89.9 in January to 91.2 in April and from 92 to 92.6 in the Eurozone.  

However the Inflation indices paint a gloomy picture for the Eurozone. The UK index, (which measures expected inflationary  pressures over the next three months and is scaled to 100 for long term trend inflation) shows deflationary expectations have receded, with the index rising from 86.6 in January to 91.5 in April.  In contrast, Eurozone businesses are now clearly very concerned about the risk of deflation, with the index plummeting from 97.1 in January to an all-time-low of 88.4 in April.  Germany’s deflationary prospects look bleakest by some margin, with the index falling from 91.2 in January to 80.6 in April, an extraordinarily low level.

The UK’s apparent resilience against deflation compared to the Eurozone suggests the depreciation of sterling against the Euro and Dollar coupled with the Bank of England’s move to quantitative easing, is helping the UK to ensure it does not undershoot its inflation target in the medium term.  This gives the UK a better chance of quicker recovery than those Eurozone economies where deflationary expectations are taking hold. The European Central Bank has not yet adopted quantitative easing and has cut interest rates less aggressively than the Bank of England.  As a result, the euro remains at too high a level and the eurozone is suffering from very weak levels of demand.

Peter Hemington, partner at BDO LLP, said: “Despite being greeted with scepticism, quantitative easing looks to have paid off so far for the Bank of England.  The European Central Bank now needs to make some bold decisions of its own if it is to stave off the threat of deflation in the Eurozone.  The ECB will be considering following the UK’s lead by printing more money or extending its Special Liquidity Scheme and all eyes will be on the ECB when it announces its interest rate decision on 7th May. By accepting now that devaluation of the Euro is a necessary evil to ensure Eurozone countries can grow their way out of the recession, the ECB may be able to hasten recovery”. 

-Ends-

For more information or a copy of the full report, please contact Rebecca Harper at Blue Rubicon on 020 7260 2700, or Stephanie Aneto at BDO on 0207 893 3073. Out of office hours, please contact Rebecca Harper on 07717 317015.

Notes to editors:

1. The BDO Business Trends Report Indices are calculated by taking a weighted average of the results of all the UK’s main business surveys carried out during the last month.

2. The Euro area indices are calculated by taking a weighted average of the results of the Europe’s main business surveys. They incorporate the results of the German IFO surveys, French INSEE surveys, Italian ISAE surveys, plus the main business surveys from the Austrian WIFO, Belgium National Bank, Spanish MCYT, Greek Foundation of Economics and Industrial Research, Irish Economic and Social Research Institute, the STATEC survey from Luxembourg, the Confederation of Finnish Industry and Employers, the Dutch central Bureau of statistics and the Portuguese INE surveys as well as the Chartered Institute of Purchasing and Supply’s Surveys of Manufacturing and of Services for Europe.

3. Methodological notes:

The BDO Monthly Business Trends Indices are prepared on behalf of BDO by the centre for economics and business research (cebr).

Taken together the surveys cover over 11,000 different respondents from companies employing approximately five million employees. The respondents cover a range of different industries and a range of different business functions. Together they make up the most representative measure of business trends available.

The surveys are weighted together by a three-stage process. First, the results of each individual survey are correlated against the relevant economic cycles for manufacturing and services. This determines the extent of the correlations between each set of survey results and the relevant timing relationships. Then the surveys are weighted together based on their scaling, on the extent of these correlations and the timing of their relationships with the relevant reference cycles. Finally, the weighted total is scaled into an index with 100 as the mean, the average of the past two cyclical peaks as 110 and the average of the past two cyclical troughs as 90.

The results can not only be used as indicators of turning points in the economy but also, because of their method of construction, be seen as leading indicators of the rates of inflation and growth.

4. BDO LLP operates across the UK with over 3,000 partners and staff. BDO LLP is a UK limited liability partnership and the UK Member Firm of BDO International. BDO international is a world-wide network of public accounting firms, called BDO Member Firms. Each BDO Member Firm is an independent legal entity in its own country. The network is coordinated by BDO Global Coordination B.V., incorporated in The Netherlands, with its statutory seat in Eindhoven (trade register registration number 33205251) and with an office at Boulevard de la Woluwe 60, 1200 Brussels, Belgium, where the International Executive Office is located. In the UK the Belfast Firm is operated by a separate Partnership known as BDO Stoy Hayward - Belfast.

BDO LLP and BDO - Belfast are both authorised and regulated by the Financial Services Authority to conduct investment business.

BDO is an award winning firm. Recent achievements include:

Best Workplace UK - Financial Times 2008
Audit Team of the Year – Accountancy Age Awards 2008
Tax Team of the Year – Accountancy Age Awards 2008
Corporate Finance Deal of the Year – Accountancy Age Awards 2008
100 Best Companies to Work For - The Sunday Times 2008
The Women of Achievement Award – Women in the City 2008
Business Superbrand - Business Superbrands 2008

5. cebr is an independent economics and business research consultancy established in 1993 and provides macroeconomic forecasts and advice to City institutions, government departments, local authorities and numerous blue chip companies throughout Europe.