Global inflationary pressures have been building over the last 12 months. These rising pressures reflect emergence from the global recession of 2001–2 and fiscal laxity in several of the world's largest economies, as well as a number of temporary factors such as rising commodity prices and indirect tax increases. Inflation expectations, as reflected by yield differences between indexed and ordinary government debt, have edged up in the US, the Euro Area and the UK, as illustrated in Chart 1. US and UK inflation expectations are about 0.8 percentage points higher than at the start of 2003, while Euro Area inflation expectations have risen by about 0.4 percentage points. Our inflation projections for the major economies are reported in Table 1. We forecast an acceleration of inflation in the US, Germany, France and the UK this year relative to 2003, and expect deflation in Japan to come to an end from the middle of 2004. Stronger inflationary pressures in the US partly reflect the positive output gap, while output gaps in Canada and the Euro Area are expected to remain negative until the end of 2005 and 2006, respectively. Our output gap estimates are illustrated in Chart 2.

The economy continued to grow faster than its trend rate in the first half of 2004. Preliminary estimates show GDP rising by 0.9 per cent in the second quarter of the year. Measured on an annualised basis, this brings the average rate of growth since the middle of last year to 3.6 per cent. It is our view that this brings the economy very close to capacity. We expect the output gap to average 0.1 per cent of trend GDP this year (see chart 1).

House price inflation in the UK has been particularly high in recent years. This has led to much discussion concerning the future path of house price growth. Whether the future scenario involves a moderation or instead a sharp correction in house prices has important implications for the short to medium path of household consumption expenditure.

Government expenditure has been rising rapidly as a proportion of GDP in recent years, and has risen from 39.5 per cent in 2002 to 40.9 per cent in 2003 and 2004 and is anticipated to rise to 41.5 per cent in 2005. Around two thirds of this increase in spending is projected to be on current consumption, whilst one third is on net investment. Between the first and the last of these fiscal years we project that the government deficit, as defined by Public Sector Net Borrowing, will have also increased by 1 per cent of GDP. During that period we expect that the output gap will have closed, and hence the deterioration in the public finances must be seen as a consequence of the policy actions of the Government and not as a result of the economic cycle. These policy actions will have contributed to the current unbalanced state of the economy, where we have strong growth and high government borrowing along with a poor and deteriorating current account.

In February 1996 the Bank of England and the National Institute of Economic and Social Research significantly increased the amount of information they published about the uncertainty surrounding their central projections of inflation. In effect, and in different ways, they each began to publish a density forecast of inflation, that is, an estimate of the probability distribution of possible outcomes for future inflation. The Bank represented this graphically, as a set of forecast intervals covering 10, 20, 30, …, 90 per cent of the probability distribution, coloured red, of lighter shades for the outer bands. This was done for inflation forecasts up to eight quarters ahead, and since the distribution becomes increasingly dispersed and the intervals ‘fan out’ as the forecast horizon increases, the chart became known as the ‘fan chart’ (or, rather more informally, and noting its red colour, the ‘rivers of blood’). The National Institute represented the distribution as a histogram, in the form of a table reporting the probabilities of inflation falling in various ranges. These intervals, or ‘bins’ of the histogram, have changed from time to time; those used currently are: less than 1.5 per cent, 1.5 to 2.0 per cent, 2.0 to 2.5 per cent, and so on. The forecasts refer to the fourth quarters of the current and following years, and from the beginning have included not only inflation but also real GDP growth. Fan charts for real GDP growth first appeared in the Bank's Inflation Report in November 1997.

Since the mid-1990s, an almost universal belief has developed amongst economic commentators that the United States has undergone a productivity miracle and that European economies are now suffering from chronic sclerosis. As a result, the ‘American model’ dominates the agenda of policy towards growth and productivity performance in Britain. This paper urges caution here, given the disappointing experience of earlier British growth policies based on borrowing from the fashionable economy of the moment, including the Japanese and German economies during the 1970s and 1980s, and the American economy (again) during the 1950s and 1960s. A historical perspective suggests that: (1) successful productivity performance requires a stable institutional framework for long-term investments in human and physical capital, which the European model has been particularly good at providing over the last half century; (2) a country is constrained by its geography, so that copying without adaptation to local circumstances is rarely a good policy; (3) it is important to pay attention to the different sectors of the economy when formulating policy.

The ECOFIN Council decision of November 2003 that noted the existence of ‘excessive deficits’ in France and Germany but did not impose sanctions on these two governments was widely interpreted as sounding the death-knell for the Stability and Growth Pact. A ruling by the European Court of Justice on 13 July 2004 annulled this decision, paving the way for reform of fiscal policy coordination in the Euro Area. This article examines what caused the difficulties that have arisen, reviews and appraises a range of proposals for reform of EMU's fiscal policy rules and suggests a way forward.

Almost one in ten adults in Britain do not use mainstream financial services. Most of them are not in paid employment. However, most people without paid work have accounts. Two hypotheses have been put forward: (i) reluctance by financial institutions to serve low-income customers; and (ii) information failure on the part of non-consumers. Using two different data sources, we find that non-consumers of financial services are distinguishable from consumers only by belonging to social networks where financial services usage is relatively low. As social networks play a key role in transmitting information, this supports the information failure hypothesis.