Bank of England Halts Interest Rate Hikes Amid Cooling Economy

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Bank of England Halts Interest Rate Hikes Amid Cooling Economy

The Bank of England (BoE) kept the base rate on hold today, marking a pause after 14 consecutive interest rate rises. The decision was influenced by lower-than-expected inflation numbers and a series of economic reports suggesting a cooling down of the economy. However, it remains uncertain whether the current 5.25% will be the peak for the base rate or if rates could start to climb again.

The BoE's decision to halt the rate increases has significant implications for savings rates and mortgage rates, which were discussed by Georgie Frost, Lee Boyce and Simon Lambert today. The trio explored why interest rates were held, what factors contributed to the dip in inflation, potential future scenarios, and what these developments mean for savers, borrowers, and investors.

The BoE's decision follows strong criticism for its failure to predict the surge in inflation that peaked at 11% in autumn 2022. In response to this criticism, the bank has commissioned former Federal Reserve chairman Ben Bernanke to review its forecasting models for both inflation and GDP growth.

An independent analysis comparing the BoE's performance with other forecasting models highlighted two key errors. First, the bank under-predicted inflation in 2021 compared to an international econometric vector autoregressive model. Second, it over-predicted peak inflation in the final quarter of 2022, expecting 13.1% when it came in at 10.8%. These miscalculations led to larger-than-usual interest rate hikes and potentially increased the likelihood of a UK recession in the coming months.

The BoE's forecasts have been accurate over a 15-year period but have faltered significantly over the past two years when inflation has been high. The bank's forecasts have been particularly inaccurate following the initiation of quantitative easing (QE) in 2009, raising questions about its understanding of the policy's impact.

The latest inflation data, published on September 20, indicates a 6.8% inflation rate for the third quarter of 2023. Both the BoE's forecasts and the international econometric vector autoregressive model predict this fairly accurately, while other models over-predict.

In light of these findings, suggestions have been made for the BoE to be more transparent about its inflation model and to consider hosting a "prediction tournament" to measure its model's effectiveness against rivals. This open-sourcing of forecasting harks back to an annual conference run by Professor Kenneth Wallis of the University of Warwick in the 1980s and 1990s, which assessed various institutions' economic forecasting models. The revival of such a conference could be a part of Ben Bernanke's review of the BoE’s forecasting.

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