This might, therefore, be an example of the media believing bad news makes a good story and then, because of the tone of their reporting, making it worse by creating a climate of uncertainty. Or it could just be the difference between popular perceptions of what is going on and the technical definitions that economists use. What is certainly apparent is that activity this year has weakened significantly from the 3.1% GDP growth in 2007 and that, in many of the areas that matter most to people, such as the housing market, all the recent trends have been negative. Even if it is not a technical recession, in some sectors of the country and in some regions, it will feel like it.

Pessimism problems
Although a slowdown was widely expected, the speed with which the economy has deteriorated has accelerated in recent months. Retailing and construction have been at the forefront of the squeeze for most of 2008, but if the regular surveys of business opinion are correct, the pessimism has now spread to services generally (including financial services) and manufacturing. And the labour market seems to be turning, with unemployment starting to edge up from the historically low levels of recent years.

What is probably now casting a long shadow over the short-term outlook is that the traditional policy responses are not available. Fiscal policy is rarely used nowadays as a tool of economic management, but even if the authorities were tempted to ease taxes to stimulate spending, they are boxed in by the government’s high levels of spending and borrowing.

So, it all comes down to interest rates. But the jump in inflation to an above-target 3.8% in June has restricted the Bank of England’s Monetary Policy Committee’s (MPC) room for manoeuvre, to the extent that some commentators have called for rate rises to curb inflation, rather than cuts to boost demand. Mervyn King and his colleagues, however, accept that policy changes take months, rather than weeks, to work through the system. They do not, therefore, respond to the current numbers – they look to the medium term.

It is the Bank of England’s view that the pressures on inflation towards the end of this year and going into 2009 will be downwards, even if there are one or two more unpleasant surprises in the short term. Less money being spent on the high street will have the effect of bearing down on price rises and if the global economy weakens (particularly the US and China), it should partly reverse the rise in oil prices. Since, moreover, much of the domestic inflation is a result of the global economy, higher interest rates will do little to dampen imported prices. Finally, higher oil prices, which have far-reaching effects across the personal and corporate sectors in the UK, are having the same impact as higher interest rates. They are changing relative prices, and because they are paying more for energy, consumers have less in their pockets to spend elsewhere.

This of course does depend on earnings growth staying at or around current rates. If consumers try to compensate for higher petrol and food bills by increasing their pay, it will only spark the sort of wageprice spiral that has undermined our economy a number of times since the 1960s.

Some belt-tightening is inevitable and if earnings growth looks like taking off, the MPC will respond quickly by raising interest rates. Otherwise, there are some more cuts in the pipeline over the next 18 months, which should help get the economy back on track in a gradual and very measured way.

Dennis Turner is chief economist at HSBC