The economy forecast

Conditioning assumptions

This Forecast in-depth page has been updated with information available at the time of the March 2024 Economic and fiscal outlook.

We forecast several variables by using the expected values that are implicit in the prices of 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 these values. We use this approach for oil prices, natural gas prices and interest rates. We also forecast equity prices by using the latest market values and projecting them to grow in line with our forecast for nominal GDP. The exchange rate is assumed to follow a ‘random walk’, meaning it is held flat over the forecast period. The rest of the economy forecast is then in effect conditioned on these implied financial market expectations of the likely future paths of these variables.

Financial market indicators can be volatile, responding to news and events from day-to-day. We therefore normally base our forecasts on the market-implied expectations over a 10-working 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. For our March 2024 forecast, this was the 10 working days up to and including 23rd January. Usually, 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. We would normally set the 10-working day window for our final economy forecast to be as near as possible to the point where we close down the forecast to everything but the effects of new policies. But on occasion, we have adopted other approaches – for instance, our March 2023 economy and fiscal forecasts were based on an average of the five days following the publication of the Bank of England’s February 2023 Monetary Policy Report so that the expectations fully incorporated the information contained in the report.

  Gas and oil prices

Our March 2024 natural gas price forecast is, over its first three years, based on the average path implied by the UK natural gas futures curve. For our economy and fiscal forecasts, we took the 10 working days to our collection date. Similarly, our oil price forecast over the first three years of the forecast is based on the average path implied by the Brent, Forties and Oseberg crude futures curve for the 10 working days to our collection date. The reason we used futures curves for the first three years in our recent forecast was because movements in gas price futures were unusually significant over that period (we previously used futures curves for only two years). Beyond that point, we grow both prices in line with a price index based on major countries’ CPI inflation. This is because at extended horizons, we believe commodity futures markets are not sufficiently liquid to give a reliable representation of market expectations for prices. This methodology is informed by IMF analysis that suggests commodity futures curves are not the best predictor of spot prices at extended horizons.[1]

[1] Reichsfeld and Roache, November 2011, IMF Working Paper: Do Commodity Futures Help Forecast Spot Prices?

[1] Reichsfeld and Roache, November 2011, IMF Working Paper: Do Commodity Futures Help Forecast Spot Prices?

[1] Reichsfeld and Roache, November 2011, IMF Working Paper: Do Commodity Futures Help Forecast Spot Prices?

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  UK interest rates

The expected paths for a number of measures of UK interest rates – notably Bank Rate (set by the Bank of England) and gilt yields (the market-determined interest rate paid on government bonds) are derived from financial market instruments including sterling overnight indexed swap (OIS) rates. As described above, in our March 2024 forecast we took an average of the market-implied path for each of the 10 working days up to and including our collection date for each of these variables.

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  World interest rates

We take an asset-weighted average of both short-term and long-term interest rates for the USA, Canada, Japan and Euro-area, using data collected from interest rate futures markets.

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  Exchange rates

In our March 2024 forecast, our trade-weighted sterling effective exchange rate index (ERI) economy and fiscal forecasts took 10 working day averages of the latest outturn, and then held these averages constant over the forecast horizon. We take the same approach with both the sterling/dollar and sterling/euro exchange rate.

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  Equity prices

We assume that the FTSE All-Share index will be equal to the 10-working day average up to and including the collection date over the remainder of the current quarter. After holding equity prices equal to this value in the very short-term, we grow prices with our forecast for nominal GDP over the remainder of the forecast period.

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  Mortgage rates

We produce a forecast for the average effective mortgage rate – the average interest rate paid on the total stock of loans secured against dwellings. This is an input into the Mortgage Interest Payments component of our RPI forecast and influences our house price forecast. It also affects our forecasts for household disposable incomes, which has an influence on our consumption forecast and so is a key driver of our overall economic forecast.

We produce forecasts for both fixed and variable effective mortgage rates. We then weight these according to their respective share of the mortgage market, and how we think that will evolve over the forecast period, to produce the average effective mortgage rate.

Both the fixed and variable mortgage rates are forecast as the sum of:

  • A “risk-free” rate. This is the rate that banks could use to fund their mortgage lending if their borrowing did not carry any default risk. We use our market-determined Bank Rate forecast as the “risk-free” rate for variable rate mortgages. For our fixed-rate mortgage forecast, we use a rolling weighted average of market expectations for 2- and 5-year swap rates – these match the maturity of the most common fixed-rate mortgages. The swap rates will account for some of the term premia associated with fixed-rate mortgages.
  • A credit spread. In reality, bank borrowing is not without risk, so we need to add a credit spread onto the “risk-free” rate to approximate actual bank borrowing costs. After the 2008 financial crisis, a widening of the spread emerged between the “risk-free” rate and the mortgage rates faced by households. This was mainly because lending to banks was considered a riskier prospect. For both fixed and variable rate mortgages we take a 2-year rolling average of major UK banks’ five-year Credit Default Swap premia (using data from the Bank of England) to approximate the credit spread faced by banks.
  • A margin. The other part of the spread between risk-free rates and mortgage rates is the margin. This will include any difference between our estimate of bank’s borrowing costs and actual costs, other operating costs and profit margins. This part of the forecast comes down to BRC judgment informed by staff analysis about future changes to banks’ operating costs, market competition conditions, the state of bank balance sheets, the composition of borrowing, the riskiness of lending and the effect of market regulations.

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  Deposit rates

We produce a forecast for the average effective rate of interest paid on the stock of household deposits. This is a weighted sum of the average effective rate on sight and time deposits. As deposits are one of the main sources that banks use to fund mortgages, we base this forecast on the evolution of the retail margin – the gap between deposit and mortgage rates. This is based on BRC judgements around banking sector competitiveness and profits plus the state of their balance sheets and other forms of funding. In recent forecasts, we have assumed that the retail margin will be fairly constant, meaning we assume that deposit rates move broadly in line with mortgage rates over the forecast.

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Boxes

Within each of our key publications we include topical ‘boxes’. These self-contained analyses are unique to this publication and tend to cover recent developments in the economy or public finances that complement the main discussion of our analyses.

Why has recent inflation been stronger than we forecast?

Chart A: Side-by-side charts: combination chart showing inflation, earnings and growth since 1970 and line chart showing inflation and energy-intensity-adjusted fuel prices
Our recent forecasts have significantly underestimated inflation outturns, with the March 2021 underestimation of inflation in 2022-23 being the largest difference between forecast and outturn since the OBR began forecasting in 2010. In this box we explored the reasons that might have driven these differences since our March 2022 forecast. In particular, we considered the extent to which the knock-on effects of higher energy prices on CPI inflation might have been higher than we originally assumed.

How gas demand and supply have responded to higher gas prices

Chart 2A: UK demand for and supply of gas
In response to the largest rise in energy prices in around 50 years, an immediate reduction in energy demand, and more gradual change in the composition of energy supply, might be expected. In this box we look at how the sharp rise in the household price of gas has changed households consumption of gas this winter as well as how the Russian invasion of Ukraine and the rise in wholesale gas prices has changed the UK's energy supply over the last year and how it may change further in the future. We then briefly outline how we forecast gas prices and why we do so.

The outlook for household income and consumption

Chart A: Real household disposable income per person
In 2022-23 and 2023-24, living standards are set for the largest fall on record. This box set out our forecast for real household income, the impact of government policy in buffering the income shock, and its implications for our consumption forecast.

Why has real household disposable income been stronger than forecast?

Chart D: RHDI per person: combined charts: line chart showing RHDI per person and stacked bar chart showing contributions to growth in RHDI per person
Real household disposable income turned out stronger than our recent forecasts expected for 2022-23. This box explained that differences are largely explained by net benefits and taxes as well as non-labour incomes providing stronger support to living standards than forecast.

Economic implications of further instability in the Middle East

Chart 2B: Line chart and stacked bar chart showing CPI inflation in the adverse scenario
As tensions have risen in the Middle East, there has been increasing concern over the possibility of a wider escalation in the region and its implications on the UK economy. In this box we considered the economic growth and inflationary implications of an adverse scenario. In this scenario, supply chain disruption reaches levels not seen since the pandemic levels and energy costs rise sharply for a second time since the pandemic.

The source of inflation and its fiscal consequences

Line chart showing terms of trade and stacked bar chart showing inflation in 2023
In our November 2023 forecast we expect inflation to be both more persistent and more domestically generated than in March. In this box we explored the reasons behind our assessment for inflation to be more domestically rather than externally driven and its implications for the public finances.

Why have oil prices fallen by so much?

Why have oil prices fallen by so much?
An important economic development in the run-up to our March 2015 Economic and fiscal outlook was the sharp drop in oil prices, which had fallen to less than half the $115-a-barrel peak that they had reached in June 2014. In this box we considered the relative importance of demand- and supply-side factors in explaining lower oil prices. (See also Box 3.1 from that EFO for a discussion of the effects of those lower prices on the UK economy.)

How does the Russian invasion of Ukraine affect the UK economy?

Chart 2.B: UK and global energy market indicators
Russia’s invasion of Ukraine in the run-up to our March 2022 Economic and fiscal outlook represented a significant adverse shock, primarily via a sharp rise in gas and oil prices. In this box, we considered where the UK gets its energy from and the channels through which higher energy prices raise inflation. We then set out how the economic shock from the invasion had been reflected in our forecast as well as several potential channels through which the invasion could affect the UK economy that our forecast did not explicitly capture.

Lower-than-expected growth in 2010-11

Lower-than-expected growth in 2010-11
UK GDP had grown less quickly in 2010-11 than the OBR forecast in June 2010. This box decomposed the forecast error by expenditure component and discussed possible explanations, including the external inflation shock.

The potential impact of coronavirus on the economy and public finances

The potential impact of coronavirus on the economy and public finances
After we closed our March 2020 pre-measures forecast, it became clear that the spread of coronavirus would be far wider than assumed in our central forecast. This box described the effect we incorporated into the central forecast and explored the potential impacts the virus could have on the economy and public finances.

Impact of post-referendum rise in inflation on the public

Impact of post-referendum rise in inflation on the public
One unforeseen economic development affecting our March 2016 forecast was the upside surprise in inflation in 2017-18 as a result of the fall in the exchange rate. This box described the effect of that surprise on receipts, spending and borrowing.

Forward guidance by the Monetary Policy Committee

On 7 August 2013, the Bank of England announced that it would not consider raising Bank Rate, then at 0.5 per cent, until the unemployment rate had fallen to 7.0 per cent. However, the Bank also detailed certain conditions, which if breached, would make it consider tightening monetary policy sooner. This box, from our December 2013 Economic and fiscal outlook, examined where our forecast stood in relation to these conditions.

Oil prices and the economy

An important economic development in the run-up to our March 2015 Economic and fiscal outlook was the sharp drop in oil prices, which had fallen to less than half the $115-a-barrel peak that they had reached in June 2014. In this box we considered the channels along which those lower oil prices were likely to affect the UK economy. (See also Box 2.1 from that EFO for a discussion of the demand- and supply-side factors contributing to lower oil prices.)

Recent trends in consumer credit

Recent trends in consumer credit
Strong growth in consumer credit in the run-up to our March 2017 Economic and fiscal outlook had prompted concerns among some commentators about its sustainability. In this box we considered the drivers of consumer credit growth, including the role of dealership car finance, and the extent to which it may have supported household consumption growth.

The economic effects of supply bottlenecks

Chart 2.D: Shifting demand and bottlenecks to supply are impacting prices
In October 2021 commentators became increasingly concerned that the inability of supply to keep up with demand in specific areas of the economy would hold back the recovery. In this box we examined these 'supply bottlenecks' in energy, product and labour markets, discussing their consequences for wage and price inflation.

The oil price and the economic forecast

At the time of publication, oil prices had risen by £15 since the previous forecast. This box, from our March 2011 Economic and fiscal outlook, considered the potential economic implications, including the short-run effects on inflation and household consumption as well as possible longer-run effects on potential supply and the equilibrium capital stock.

Bank deposits, mortgage lending and the housing recovery

Bank deposits, mortgage lending and the housing recovery
In 2013, households’ balances in ‘time deposit’ accounts (savings with fixed maturity) fell by £36 billion. This box outlined possible reasons for this by exploring the wider household savings behaviour. The cumulative change in annual deposit flows showed rapid increases in 'sight deposits'. This was possibly explained by narrowing spreads between 'time' and 'sight' deposit interest rates or normalisation of household investment behaviour. Changes in annual mortgage flows also suggested that revival of housing market activity could have been responsible for switching between deposit types. The ability of households to shift very large deposit balances over relatively short timeframes was one reason why the impact of savings and pensions measures discussed in Box 3.3 of the same EFO was subject to considerable uncertainty.

The sensitivity of our central forecast to gas prices and interest rates

Chart E: Sensitivity of PSNB and underlying debt to interest rates
In 2022-23 we have seen sharp rises in gas prices and interest rates, both of which are forecast to remain elevated in 2023-24. This box presented the potential fiscal impacts of a higher-than forecast path for gas prices and two scenarios where Bank Rate is either a percentage point higher or lower than in our central forecast.

The impact of rising interest rates in household finances

The impact of rising interest rates in household finances
We expected debt servicing costs as a share of disposable income, or ‘income leverage’, to rise as our forecasts for house price inflation outstripped income growth and Bank Rate gradually increased. This box discussed the extent to which mortgage servicing costs were likely to increase over the forecast period and the implications of this for household behaviour, using information from the Bank of England/NMG survey.

A history of natural gas in the UK

Chart 3A: Energy consumption and gas supply
Since 1970 the UK's energy sector has undergone significant shifts following the discovery of oil and gas in the North Sea and the energy shocks of the 1970s. In this box we summarised the historical events and changes that has led to the UK has become increasingly dependent on imported gas.

Energy prices and potential output: a production function approach

Persistently higher energy prices can reduce the supply capacity of the economy. In this box, we use a production function to estimate the impact of higher fossil fuel prices on potential output.

May 2022 cost of living support package

In May 2022, the Government announced a package of measures to support households with the cost of living. In this box, we explained how we had adjusted our March 2022 Economic and fiscal outlook forecast for these policies.

Short and long-term interest rates in the pre-Budget and Budget forecasts

Ahead of the June 2010 forecast, the OBR published a 'pre-measures' forecast, noting that the use of market expectations of interest in that forecast was potentially inconsistent, depending on markets' expectations of both fiscal tightening and the MPC's reaction to it. This box set out some illustrative calculations of the possible impact of the June 2010 Budget on long-term interest rates, and discussed the possible implications for comparisons between the pre-Budget and June Budget forecast

The oil price and the fiscal forecast

The oil price and the fiscal forecast
The world price of oil increased sharply in 2010, reflecting rising world demand and unrest in the Middle East and North Africa. This box explored the impact this had on our public finances forecast at the time, from higher North Sea oil and gas revenues to the second round effects stemming from higher inflation.

Recent interest rates rises and financial stability

Chart 5A: Financial market-implied and actual Bank Rate path
There has been a notable shift in the environment of interest rates over the past 18 months in the UK. This box looked at the extent of surprise for rate rises relative to market implied expectations and the increase in capital adequacy ratios of UK banks since the global financial crisis.

Forecasting debt interest spending

Forecasting debt interest spending
Our March 2015 Economic and fiscal outlook forecast highlighted large changes in our debt interest forecast since previous fiscal events and the added complexity that debt interest was expressed net of the effect of gilts held by the Bank of England Asset Purchase Facility (APF) associated with past quantitative easing. This box described how we produced the debt interest forecast and illustrated some of the sensitivities to which it was subject.

A simple analytical model of the capital market

Figure A: Determination of rates of return
The yields on government debt have declined over recent decades. This box described a stylised model that provides a framework to explain the drivers of these changes.

Debt interest spending and the yield curve

Debt interest spending and the yield curve
Since our March 2014 Economic and fiscal outlook, our debt interest spending forecast was revised down significantly as market expectations of the interest rates at which the Government can borrow and service its debt moved progressively lower and as inflation fell. This box explained some possible factors that could have caused market expectations of interest rates to rise and the effect on the fiscal position of a sudden increase in interest rates.

The impact of the pandemic on real interest rates

Chart B: The impact of past pandemics and wars on interest rates (swathe chart)
Past pandemics have had long-run impacts on real interest rates. A recent paper found that 20 years after a pandemic real rates fell by, on average, 1.5 percentage points (though less in the UK). This box examined the evidence for the current pandemic and suggested why this time it may be different.

Changes in our forecast for the debt profile in 2015-16

Changes in our forecast for the debt profile in 2015-16
In our first June 2010 EFO, the debt-to-GDP ratio was forecast to fall by 2 per cent in 2015-16. This box explored how our debt-to-GDP forecast for 2015-16 evolved over time. It highlighted the contribution of the primary balance and the impact of other factors (including asset sales and the growth-interest differential) on the debt-to-GDP ratio forecast.