Our economy forecasts include a number of variables where we judge the best way to produce a forecast is to use the future values that are implicit in the prices of various financial market instruments. Since these reflect the collective views of the large number of investors in each market, it seems unlikely that our own forecasts could systematically outperform the market. We use this approach to forecast oil prices, interest rates and the exchange rate. We also forecast equity prices by using the latest market values and other assumptions. The rest of the forecast is then in effect conditioned on these implied financial market expectations of the most likely future path of these variables.
Financial market indicators can be volatile, responding to news and events from day to day. We control for this by basing our forecasts on the market-implied expectations over a 10-day window – a period that aims to be short enough to capture the latest market view, but long enough to be less susceptible to day-to-day volatility. At the start of the forecast process, we agree a forecast timetable with the Treasury that includes the dates at which we will take financial market expectations. Usually, we set the 10-day window for our final economy forecast to be as close as possible to the point where we close down the forecast to everything but the effects of new policies. We could move away from that if there were events that we might expect to distort indicators of financial market sentiment around that time.
The main conditioning assumptions we use in our forecast are: