The Bank of England Launches Review of Economic Forecasting Process

The Bank of England (BoE) has announced a review of its economic forecasting process following criticism for its failure to accurately predict the rise in UK inflation. The review comes after calls for an overhaul of forecasting processes by a cross-party group of lawmakers who have expressed concerns about the accuracy of the BoE’s own models and the reduced role of the Monetary Policy Committee (MPC) in setting interest rates.

External Review to Assess Forecasting Processes

In May, the BoE governing body decided to commission a broad external review of its “forecasts and related processes during periods of significant uncertainty.” The review aims to evaluate the effectiveness of the BoE’s forecasting platform, the transparency of the forecasting process, and the openness of the bank to external challenges. The review will likely draw on international expertise and have a broader scope than initially suggested by the Treasury committee.

Concerns Raised Over Inflation and Interest Rates

Traders have been increasing bets on further interest rate hikes as mortgage lenders rush to re-rate loans. BoE Governor Andrew Bailey’s recent admission that it would take “much longer than expected” for inflation to fall from its current level of 8.7% has heightened concerns. Market data suggests that interest rates, currently at 4.5%, could peak near 5.75% later this year.

MPC’s Role in Setting Interest Rates

Members of the MPC have stated that the BoE’s own models are not producing accurate results, leading to calls for an overhaul of forecasting processes. The MPC has also reduced its role in setting interest rates, prompting concerns about its ability to effectively respond to economic challenges. The external review aims to assess both technical ways to improve the BoE and how the MPC uses forecasts when setting policy and communicating decisions.

Exploring the Challenges and Limitations of Economic Forecasting

Economic forecasting is a complex process that relies on a range of models, data, and assumptions. However, recent events have highlighted the limitations of traditional forecasting methods in the face of major shocks and uncertainties. Huw Pill, the BoE’s chief economist, has acknowledged that models based on the past 30 years may not accurately capture the dynamics of the current economic landscape.

Learning from Mistakes and Enhancing Forecasting Models

Pill has emphasized the importance of understanding the mistakes made in forecasting inflation and using them as a basis for improving forecasting models. The review will delve into the reasons behind these errors and assess whether they are likely to continue in the future. By identifying shortcomings in the current approach, the BoE aims to enhance its forecasting capabilities and provide more accurate predictions.

Moving Towards Scenario-Based Reporting

One of the broader questions raised by the review is whether the MPC should continue focusing on a central prediction or shift towards scenario-based reporting. Scenario-based reporting would involve presenting a range of possible outcomes, allowing MPC members to explain their voting decisions when there is a divergence of opinions within the committee. This approach could improve transparency and provide a more nuanced understanding of the factors influencing interest rate decisions.

Conclusion

The Bank of England has launched a review of its economic forecasting process in response to criticism and concerns about its accuracy and effectiveness. The external review aims to assess the transparency and openness of the forecasting process, as well as the technical aspects of forecasting models. The review will likely draw on international expertise to provide a comprehensive evaluation of the BoE’s forecasting capabilities.

The Bank of England has launched a review of the way it makes and uses economic forecasts after being criticized by politicians for repeatedly failing to forecast the rise and persistence of UK inflation.

In a letter On Wednesday, David Roberts told the House of Commons Treasury Committee that the central bank governing body, which he chairs, had decided in May to commission a broad external review of its “forecasts and related processes during periods of significant uncertainty”.

The revision announcement came as traders increased bets on further interest rate hikes and mortgage lenders rushed to re-rate loans, in the wake of BoE Governor Andrew Bailey admission that it would take “much longer than we expected” for inflation to fall from its current level of 8.7%.

Markets are betting that interest rates, now at 4.5%, will peak near 5.75% later this year, following economic data suggesting that the UK’s inflation problem will be harder to tackle than elsewhere.

The cross-party group of lawmakers had called for an overhaul of forecasting processes after members of the Monetary Policy Committee, which sets the base rate, told them that the BoE’s own models were not producing accurate results and that the MPC had reduced its role in setting rates.

In a letter earlier this week, commission chair Harriett Baldwin urged the BoE’s Administrative Tribunal to assess “the current effectiveness of the Bank’s forecasting platform”, the transparency of the forecasting process and whether it was open enough to external challenges. Roberts described her call as “timely”.

While the BoE has yet to set the terms of the review or decide who will lead it, it is likely to draw on international expertise and give it a broader scope than suggested by the Treasury committee, examining both technical ways to improve BoE and how the MPC uses forecasts when setting policy and communicating its decisions.

Huw Pill, the BoE’s chief economist, told the committee last month that it was “almost inevitable” that models based on the past 30 years would fare poorly in the face of major new shocks. He added that the MPC was “trying to understand why we made those mistakes. . . and then make an assessment of whether that behavior will continue into the future.”

Broader questions, however, include whether the MPC should still focus its reporting on a central prediction – presented as the committee’s collective judgment – or whether it would be better to publish scenarios, helping MPC members explain their vote when the committee has been divided.