- Bank of England and OBR’s forecasts offer different projections for the year ahead
- This raises an important question - how useful are they?
As the year draws to a close, thoughts turn to what 2023 has in store for the UK economy. We should have pretty good visibility: after all, both the Bank of England (BoE) and the Office for Budget Responsibility (OBR) treated us to expansive projections in November. The problem is that they both offer different visions of what lies ahead.
Take growth. There is, at least, some consensus that the combined forces of high inflation, rising interest rates and falling house prices will weigh on consumption next year, causing the economy to contract. But the Bank and the OBR do not agree on the magnitude of the recession ahead. While the OBR forecasts a recession lasting until the end of next year, the BoE expects a longer contraction, with the economy only returning to growth in Q3 of 2024. Depending on which you believe, the UK could be facing the longest recession since records began, or something altogether milder.
Inflation projections also vary, as my chart shows. Both the OBR and the BoE agree that inflation will eventually drop below target but crucially, the Bank expects us to avoid the spectre of deflation while the OBR does not. As my chart shows, the OBR forecasts a protracted period of deflation, with CPI dropping to -1.3 per cent. This might sound meagre, but with deflation, a little goes a long way. For context, -1.35 percent was the ‘deepest’ rate of deflation Japan experienced in the aftermath of the financial crisis.
In times of high uncertainty, it is no surprise that forecasts come to different conclusions. The OBR notes that in the 16 weeks before the Autumn Statement it had produced “seven forecast rounds under three prime ministers and three chancellors, working towards three official forecast dates” while the BoE’s November forecasts were produced without any knowledge of the Autumn Statement’s policies at all. Energy prices are also extremely difficult to project: this time last year, few would have foreseen the invasion of Ukraine, nor the political turbulence that blighted the UK over the second half of this year.
But some of the forecast assumptions do merit closer scrutiny. Take savings: the Bank expects the savings ratio to rise as households add to ‘precautionary savings’ in the face of the darkening economic outlook. But the OBR anticipates the opposite, forecasting that the savings ratio will fall from a lockdown-induced peak of 24 per cent down to zero by the end of next year. It also expects consumers to draw on their savings. This subtle distinction matters: if a savings buffer helps consumers to maintain existing levels of spending, the impending recession would prove significantly milder.
Interest rates pose another forecasting challenge. In November, the Bank of England produced two alternative forecasts, one using a 3 per cent interest rate (assuming no further rate hikes) and the other using around 5 per cent (assuming interest rates follow the market implied path). Yet in the same report it cautioned both that “further increases in the Bank Rate may be required for a sustainable return of inflation to target”, and that rates would “peak lower than priced into financial markets” – effectively discounting both scenarios. The OBR subsequently used the higher market interest rate in its own forecasts, despite the Bank’s warning.
But even if conflicting forecasts leave us no clear sense of the way ahead, the differing assumptions do highlight the range of factors that UK economic performance will hinge on next year. Some of these are obvious (energy prices, the path of interest rates and fiscal policy), others (like savings rates) are more easily underestimated.
But as we read 2023 outlooks, a note of caution: economists have been bamboozled before. Dario Perkins, MD of global macro at TS Lombard urges us to “remember the overwhelming consensus this time last year: inflation would melt away quickly, global growth would stay "above trend", and central banks would start to normalise policy gradually”. The outlook may be foggy, but from this vantage point, we might reasonably expect next year to bring plummeting inflation, some form of recession and interest rate hikes of up to 5 per cent. It is sobering to think that we could be wrong on all counts.
