MacroScope

In his valedictory Quarterly Inflation Report, Bank of England Governor Mervyn King shone a ray of light on the British economy, saying it should grow 0.5 percent in the current quarter.

But according to the latest Reuters poll of more than 30 economists, published on Tuesday, that might be too optimistic.

The consensus showed gross domestic product would only expand 0.2 percent, weaker than the 0.3 percent expansion seen in the first quarter when the country missed sinking into an unprecedented triple-dip recession.

“I don’t know where he sees the growth coming from,” said economist Stephen Lewis at Monument Securities, whose forecast is in-line with the consensus.

“Perhaps he is hoping for some strong rebound after the improvement in the weather — although today it doesn’t seem all that improved,” he added from a cold and wet London.

G7 finance ministers meet London on Friday and Saturday. Since they and many more met in Washington only three weeks ago and not much has changed since, it’s tempting to ask what is the point of this British gathering. There have been mutterings from some of the travelling delegations to that effect.

If there is an angle, it is the unusual focus on financial regulation (usually not part of the Group of Seven’s remit) with some feeling that more than four years after the collapse of Lehman Brothers, efforts to put in place structures to prevent similar events spinning out of control in future are flagging. That puts the euro zone’s fluctuating plans for a banking union firmly in focus, which in turn puts German Finance Minister Wolfgang Schaeuble right in the spotlight.

On Tuesday, he said elements of a banking union would have to be pursued without lengthy and arduous treaty change, something he’d previously said would be necessary. Was that a softening of his position? Er, probably not. More likely, the subtext is that because treaty change takes too long, Berlin will pursue only those elements of banking union that don’t require it – i.e. bloc-wide regulation yes, but forget about a bank resolution mechanism let alone a joint deposit guarantee.

There’s been a lot of noise surrounding the rhetorical shift away from austerity in the euro zone in recent days, the notable exception being Germany. It is now widely acknowledged that monetary policy alone cannot turn economies around. But of course it has a vital part to play.

That puts the focus on the European Central Bank and growing expectations that it will cut interest rates to a new record low next month. Yesterday’s poor German PMI could have been the tipping point. On three of the four times the survey reading has fallen below 50 since the collapse of Lehman Brothers a rate cut followed the month after. Germany’s PMI duly slipped into contractionary territory yesterday.

In all this, we shouldn’t lose sight of the fact that a quarter-point rate cut may move markets but will have only a small impact on the euro zone economy. It’s also true that the ECB has shown no signs of wanting debt-cutting drives to be mothballed. Its reaction to any shift in that direction remains to be seen.

The big euro zone development over the weekend was the re-election of ageing Italian President Giorgio Napolitano for a second term. The presumption is that to put himself through this again he must have got pretty serious expressions of intent from the warring political parties that they will strive for some form of grand coalition. That may have been made easier by the resignation of centre-left leader Bersani who was in danger of splitting his own caucus.

If that comes to pass it should push back the timing of fresh elections until next year at least, a welcome turn for markets which feared a new poll could result in an even more fractured outcome and put more power in the hands of the anti-establishment Five Star movement. All that means we should see a significant rally in Italian assets today. That should also benefit other peripheral euro zone bonds. Safe haven German Bund futures have already dipped at the open, Italian bond futures have leapt almost a full point and European stock futures are pointing upwards.

87-year-old Napolitano will address parliament later and could either rush through consultations with the parties or skip that step altogether since he’s already heard from them ad nauseam.

Paul Volcker’s inflation-fighting era as chairman of the Federal Reserve is quite the opposite of today’s U.S. central bank, which is battling to kick start growth and even stave off deflation with trillions in bond purchases. And it is polar opposite of where the Bank of Japan finds itself today, doubling down on easing to lift inflation expectations after two decades of Japanese stagnation. After all, Volcker ratcheted up interest rates in 1979 and the early 1980s to tame the inflation that had been choking the United States.

So it may come as no real surprise that, talking to students and faculty at New York University on Monday, he had a few concerns about where the world’s ultra accommodative central banks are headed.

“There are going to be big losses at central banks at someplace along the line,” he said. “You do all this support of buying longer term securities at very low interest rates; long term interest rates aren’t going to stay where they are forever; at some point losses are going to be taken.”

The European Central Bank takes centre stage. While others in the euro zone are saying the way Cyprus was bailed out – with bank bondholders and big depositors hit – could be repeated, the ECB insists it was a one-off.

Fearful of any signs of contagion it will continue to talk that talk and there’s no sign of it having to do more so far, with no bank run even in Cyprus let alone further afield. But the last two weeks has reignited debate about what the ECB might have to do in extremis. It’s no nearer deploying its bond-buying programme but it could flood the currency area’s financial system with long-term liquidity again if called upon.

Interest rates are expected to be held at a record low 0.75 percent. Hints of policy easing further out are not out of the question. As ever, Mario Draghi’s hour long press conference will be minutely parsed but there will be nothing to match the Bank of Japan which earlier announced a stunning revamp of its policymaking rules – setting a balance sheet target which will involve printing money faster and pledging to double its government bond holdings over two years.

Britain’s independent Office for Budget Responsibility slashed its growth forecasts for this year ahead of George Osborne’s Budget on Wednesday. But looking longer-term, it now has the unusual distinction of being more optimistic about Britain’s long-term economic health than the Bank of England, often pilloried for its rose-tinted views.

And rightly so. The Bank’s famed GDP fan charts have been exceptionally over-optimistic. Until recently, it routinely suggested the economy was more likely to grow more than 5 percent annually than contract even slightly, which was plainly absurd.

In its short life, the OBR too has had its fair share of forecasting blunders. Created with the arrival of the coalition government in 2010, that June it predicted 2012 GDP growth of 2.8 percent. In Wednesday’s report, it estimated the economy instead grew 0.2 percent last year.

For all the talk about imported inflation in the UK as policymakers talk down the pound and financial markets merrily give it a good beating, here’s a stark reminder that a lot of British inflation remains home-grown.

British inflation has been so sticky over the past decade that regular Bank of England pronouncements that it will come back down from wherever it is to the 2 percent target at the 2-year horizon has become something of a policy piñata in financial markets. And there is rampant speculation the government will soon modify that inflation target.

But it’s no joke to British consumers, whose wages have stagnated for years and with a plunging currency in their pocket that is down more than 8 percent so far this year. They’ve been much more frugal with their spending, and as a result the economy is on its back.

It’s ECB day and it could be a big one, not because a shift in policy is expected but because journalists will get an hour to quiz Mario Draghi on the Italy conundrum after the central bank leaves monetary policy on hold.

To explain: The story of the last five months has been the bond-buying safety net cast by the European Central Bank which took the sting out of the currency bloc’s debt crisis. But now it has an Achilles’ heel. The ECB has stated it will only buy the bonds of a country on certain policy conditions encompassing economic reform and austerity. An unwilling or unstable Italian government may be unable to meet those conditions so in theory the ECB should stand back. But what if the euro zone’s third biggest economy comes under serious market attack? Without ECB support the whole bloc would be thrown back into crisis and yet if it does intervene, some ECB policymakers and German lawmakers will throw their hands up in horror, potentially calling the whole programme in to question.

In Italy, outgoing technocrat premier Monti is due to meet centre-left leader Bersani, the man still harbouring hopes of forming some sort of government. Whether he succeeds or not it seems unlikely that any administration can ignore the dramatic anti-austerity vote delivered by the Italian people.

Take with a pinch of salt economists who say Tuesday’s strong UK services PMI  might persuade the Bank of England to hold off from restarting its printing presses this week.

BoE policymakers been perfectly willing over the last few years to vote in favour of more asset purchases after a rise in the services PMI number.

Only the last decision for more quantitative easing — July 2012 — came after a decrease in the services PMI’s main index. While members of the Monetary Policy Committee rely on the PMIs as a monthly gauge of economic activity, it’s clear the surveys can’t be read as any proxy for policy decisions.