The perils of predicting BoE policy

February 8, 2011

BRITAIN/As we’ve noted extensively, economists often get it wrong. Leaving aside their collective failure to recognise an impending global recession, you might recall a shock interest rate hike from the Bank of England in January 2007.

This was another event that almost every economist polled by Reuters failed to spot, and there are signs that four years on, economists might be setting themselves up for a similar shock.

The consensus from the last Reuters BoE poll last week showed interest rates would stay on hold into the fourth quarter, even though UK money markets have priced in a 100 percent chance of a rate hike by May. Since the January meeting, some of the bank’s Monetary Policy Committee members have publicly stated their determination to fight strong inflation.

But going back to January 2007, the only analyst out of the 50 polled by Reuters who predicted that shock rate hike was Simon Ward, chief economist at Henderson Global Investors. If the MPC does indeed flay analysts’ consensus this year by hiking rates before April, he stands to repeat his 2007 feat by being the only economist in the last poll to forecast a hike in the first quarter.

“I have been a bit mystified as to why other people haven’t shifted (their views) as inflation figures have really shot up over the last few months,” Ward told Reuters.

He suspects a somewhat dovish speech last month from BoE Governor Mervyn King wrong-footed economists, based on the presumption that King wouldn’t have sounded so dovish unless he was confident that rates would stay on hold for a long time.

“I think that interpretation was incorrect, and King has been outvoted in the past. It’s not like the U.S., where there’s a certain amount of pressure to follow the chairman’s lead,” said Ward.

There are signs that economists are coming round to the more hawkish rate scenario portrayed by the money markets and economists like Ward. Citi economists said on Monday they were looking to March or April for a rate hike, and others have qualified their forecasts to say there is an uncertain rates outlook.

It may well be the economists are right and markets wrong – but unlike the obscure synthesis of money market expectations, economist expectations are matched by particular institutions and named analysts. Unfair perhaps, but for that reason it will be marked as another “miss” for economists at large if the BoE decides to hike rates in the next couple of months.

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