BoE prepares for ‘once in a generation’ overhaul in forecasting

The Bank of England is gearing up to overhaul the way it produces and communicates its outlook for the economy after it was criticised for failing to predict the jump in inflation after the pandemic.

Andrew Bailey, the Bank of England governor, told the Financial Times that he is expecting the central bank to drop its existing “fan chart” forecasts as part of a set of reforms that will better convey the uncertainty hanging over its economic policy outlook. 

A growing number of BoE officials are in favour of instead using projections of alternative scenarios, potentially alongside a central forecast. But analysts and officials stress that shifting to a new regime will not be easy and caution that the reforms are unlikely to be brought in rapidly. 

The Bank of England ‘fan’ chart

BoE policymakers do not release projections of where they think interest rates will go. They do put forward so-called fan chart forecasts of the economy based both on market expectations for interest rate movements and unchanged rates, showing the probabilities of different outcomes.
(See bottom of story for communication strategies of other central banks)

“This will amount to a profound change to the way the bank handles monetary policy,” said Jens Larsen, a former BoE official who is now director of geoeconomics at Eurasia Group consultancy.

“It will change the way they conduct their internal policy debate and hopefully lead to much better communications, in a world that is more volatile and where the shocks are likely to be more profound,” he added.

Like counterparts including the European Central Bank and the US Federal Reserve, the Bank of England was badly stung for failing to foresee the steep rise in inflation that followed the end of Covid-19 lockdowns. After responding with aggressive rate rises, central banks have conducted postmortems as they seek to learn the lessons of the episode.  

The BoE said last summer it had commissioned former Federal Reserve chair Ben Bernanke to produce a report on its forecasting, which is due to be published this month. 

Speaking to the FT after the BoE’s March rate-setting meeting, Bailey made it clear that he sees the changes that will follow the Bernanke report as a “once in a generation” opportunity for Britain’s central bank to upgrade its internal processes for forecasting what lies ahead for the economy and communicating this to the public and markets. 

The change will entail increased investment in the bank’s IT systems, and Bailey said the bank is also examining ways of deploying AI.

But the biggest change will be a move away from the bank’s so-called fan charts, Bailey said. Pioneered by the bank in 1996, they attempt to depict the probability of outcomes for growth and inflation under various assumptions, but have frequently been criticised as confusing. 

BoE governor Andrew Bailey: ‘We’ve got some pretty big plans’ © Charlie Bibby/FT

Some bank officials argue that “what if” scenarios would be a better way of analysing and discussing the uncertain outlook as political volatility and shocks, including wars, shake economic policymaking.

Scenarios have a pedigree in the central banking world; Sweden’s Riksbank is a long-standing proponent. Its latest monetary policy report set out officials’ principal interest rate forecast, as well as their economic outlook, alongside two alternative scenarios. 

One showed how the policy rate would evolve in a higher-inflation scenario, where international demand was stronger and there are renewed supply shocks. The other mapped out the response to a low-demand scenario. 

Jonathan Haskel, an external member of the BoE’s Monetary Policy Committee, told the FT that such scenarios would help the bank to better think through how the economy might respond to different developments. 

Scenarios would also help the BoE communicate better to the outside world and turn it into an organisation “which can learn really effectively”, he argued. 

Hawkish officials might, for example, be able to point to alternative scenarios showing more persistent inflation as they explain why they diverged from the majority in MPC votes. 

But Bailey warned that introducing scenarios would not be straightforward. Investors would get confused or frustrated if the BoE failed to clearly signal a central forecast for the future. 

And bank officials stress that careful deliberations would be needed to determine what the alternative scenarios would actually look like — and how regularly the BoE should be producing them. 

Economists said a key unresolved question was whether the new regime would involve the BoE putting forward differing forecasts for the likely path of interest rates. It currently bases its forecasts on market interest rate expectations, as well as unchanged rates.

“Publishing a rate path will help to anchor both the policy debate inside the bank and expectations outside the bank on what really matters — the appropriate path of interest rates,” said Richard Barwell, head of macro research at BNP Paribas Asset Management.

Similarly, “the most valuable information in any alternative scenario that the bank publishes is how interest rates respond”.

The BoE is also debating whether to mirror the system used at the US Federal Reserve, where officials mark their central expectations for appropriate interest rate policy in the coming years on a so-called dot plot. 

The system was first pioneered by the Fed when Bernanke was its chair, which makes it likely to have been floated in his review even if it doesn’t emerge as a formal recommendation. 

But Bailey said he was in two minds about using the Fed’s method because of the risk that individual policymakers would be pressured by politicians to reveal their rate outlooks. 

He added that he still believed the BoE’s current forecasting process worked in “normal” times but that central bankers needed to rethink their approach for a “more unstable world”. 

“We’ve got some pretty big plans,” Bailey added. 

Guiding expectations: central bank communications methods

In addition to press conferences, speeches, interviews, reports on monetary policy and, for some, minutes of policy meetings, central banks use a variety of methods to keep the public and market informed of their outlook. Here are a few of them: 

Federal Reserve

Fed policymakers release a “dot plot” of where they think official interest rates should go. The dots are not attributed to individuals. Rate-setters also set out projections of GDP and inflation expectations.

European Central Bank

ECB policymakers do not release projections of where they think interest rates will go. However the bank regularly releases staff forecasts for the economy, based on market expectations for official interest rates. These include “fan charts” for inflation and growth. The ECB also publishes alternative scenarios — for example on the impact of the Red Sea shipping disruption.  

Bank of Japan

BoJ policymakers do not release projections of where they think interest rates will go. They put forward forecasts of the economy using a dot plot of individual projections for GDP and inflation. The bank does not regularly lay out alternative scenarios.

Swedish Riksbank

The Riksbank sets out forecasts for the policy rate and key economic indicators. It also lays out alternative scenarios illustrating how monetary policy would be affected if the economy moved in unexpected directions. Individual votes by members of the executive board are disclosed. 

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