This Forecast in-depth page has been updated with information available at the time of the March 2022 Economic and fiscal outlook.

Our economy forecasts include a number of variables where we use the expected 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 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. 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 close 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, following the Russian invasion of Ukraine and the subsequent significant movements in energy prices and other key market determinants, we based our March 2022 forecast on a 5-day window instead.

  Gas and oil prices

The average path implied by the Brent crude futures curve for the 10-working days to our collection date is used for the first two years of our forecast, after which we hold the price flat in real terms using a price index based on major countries’ CPI inflation. This methodology is informed by IMF analysis that suggests that the futures curve is not the best predictor of oil prices beyond a two-year horizon.[1] That may be partly due to the oil futures market beyond the two-year horizon not being sufficiently liquid to give a reliable representation of market expectations for oil prices beyond that point.

Our March 2022 natural gas price forecast is, over its first three years, based on the average path implied by the UK natural gas futures curve for the 5-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 crude futures curve for the 5-working days to our collection date. The reason we used futures curves for the first three years in our March 2022 forecast, was because movements in gas price futures were unusually significant over that period (we had previously used futures curves for only two years). Beyond that point, we hold both prices flat in real terms using 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 that 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?

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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 2022 forecast we took an average of the market-implied path for each of the 5-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 2022 forecast, our trade-weighted sterling effective exchange rate index (ERI) forecast took a 5-working day average of the latest outturn and held this average 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 usually 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 (although, as set out above, we used 5 days in our March 2022 forecast). 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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