• • Base rates will fall to S per cent by the start of 2000 and to below 4 per cent in 2001, the lowest for almost half a century.

• • Inflation (RPI all items) will drop to 1.2 per cent in the final quarter of this year; excluding mortgage interest payments, inflation will decline to 2.1 per cent, below the government's 2.5 per cent target.

• • The manufacturing sector is now expected to contract by 1.5 per cent in 1999.

• • We continue to forecast growth of 1 per cent for the whole economy.

• • Sterling is now projected to trade at 1.36 euros to the pound (equivalent to DM2.65) from 2001 in order to pave the way for entry into EMU; this rate would amount to a 5 per cent overvaluation.

• • The prospects for the US economy in 1999 appear brighter than they did last October, but remain heavily dependent on the health of the stock market.

• • The Japanese economy is now expected to decline in 1999 by a further half a per cent following the 3 per cent fall in 1998.

• • There is a risk that Japan may enter a prolonged downward spiral without a prompt initiative to expand the money supply much more aggressively.

• • The Euro Area is slowing down to growth of little more than 2 per cent in 1999.

• • With consumer price inflation of only 1 per cent in the euro area, there is scope for a further half a percentage point cut in euro interest rates; we anticipate a quarter point reduction this spring.

Over the past three months, the good news about the economy has outweighed the bad and the chance of a very steep recession has receded. The widespread gloom that was evident in the autumn has partly lifted. This is most apparent in equity prices, which are now at record levels. But survey evidence is also beginning to suggest that firms and households are more confident than they were, especially with regard to their own situation.

Government borrowing has fallen sharply over recent years as tight expenditure control has been combined with buoyant revenue. It now appears likely that the budget will be in surplus in the current fiscal year, with the Golden Rule clearly met. A decline in the deficit has been one of the key objectives of fiscal policy for a number of years. Indeed the Financial Statement and Budget Report (FSBR) of November 1994 projected a £1 billion surplus in 1998–99, although several policy measures have had to be implemented since then in order to achieve it.

The world economy continues to face strong deflationary pressures at the present time. Whilst growth has remained above trend levels in North America, the Japanese economy has sunk further into recession, and there are increasing signs of an economic slowdown in Europe. Overall we expect GDP growth in the OECD economies to slow to around 1.8 per cent this year, from an estimated 2.4 per cent in 1998. Global demand as a whole remains relatively weak, with the growth in the volume of world merchandise trade estimated to have halved last year to around 5 per cent and projected to fall further to between 4-4½ per cent this year. Trade in Asia is estimated to have declined by 7½ per cent last year, with potentially serious consequences for growth prospects in economies such as China, Hong Kong and Singapore that have become increasingly affected by the regional economic downturn.

Recent economic data indicate that the momentum of the present cyclical expansion in the United States continues to be stronger than widely expected at the beginning of last year. GDP is provisionally estimated to have risen by around 3¾ per cent in 1998, with domestic demand rising by 5 per cent. The last three years have all now seen output growth of 3½-4 per cent with high resource utilisation but low, and declining, price inflation.

In this section we initially discuss developments in Europe as a whole, and present a forecast for the Euro Area for the first time in Table 10. With inflation subdued in the Euro Area, there is a case for potential further reductions in interest rates in the short term, and we investigate the potential effects from such a monetary relaxation in Box A. This allows us to say something about potential asymmetric national reactions to a given monetary policy change, and also about the effects of faster growth on fiscal positions. There had been fears that the birth of the Euro would be accompanied by some loosening of the fiscal stance, but there does not appear to be much risk of this at present. We also discuss fiscal prospects in the EU, and highlight key developments in each country.

The book just published is a study of the five major recessions since 1920, and seeks to establish their causes. It focuses on the UK, but sets events there in their international context, and makes frequent comparisons with other countries. It concentrates on the major recessions not only because the effects are greater, but because behaviour in big and small recessions differ; and appears to be the first study to do so.

The question whether the US equity market is overvalued is important from a policy perspective because a significant derating could interact adversely with the realisation of risks of recession. A simple dividend based model suggests that the market is two or three times overvalued. Allowing for stock buybacks, takeovers for cash and temporary unsustainable earnings growth leave the market overvalued by 20–30 per cent. The ‘New Economy’ view that recessions are things of the past and that technical change justifies permanently higher earnings growth is implausible. An influential argument that the traditional premium earned by equities over bonds is too high is itself theoretically special. Similarly the recent relationship between US inflation and the risk premium has not held at other times and places, while the fact that most wealth is held by middle-aged people with limited time horizons supports a larger premium. Our best guess is that the current premium is 1.7 per cent p.a. which is near the lower end of the historical range although equity investors do not appear to be prepared for lower returns in the face of the possibility of global recession in the next 12–18 months. The risk that a US market adjustment might aggravate such a recession in the US itself is a basis for reconsidering central banks' disregard of asset prices in setting monetary policy.

This article examines the statistical issues surrounding the Bank of England's density forecast of inflation and its presentation as a ‘fan chart’. The Bank's preferred central projection is the mode of the density but this underestimates ‘average inflation over a number of years’ in terms of which monetary stability is defined. An alternative fan chart based on central prediction intervals is presented, better reflecting the extent to which the overall balance of risks is on the upside of the inflation target. An ‘all-or-nothing’ loss function is seen to be implicit in the Bank's choices of statistical measures, but is unrealistic.