Dario Bonciani and Johannes Fischer

The UK economy has been hit by significant terms-of-trade shocks, most notably the rise in energy prices following the Russian invasion of Ukraine. These shocks have created substantial and persistent inflationary pressure in many countries. Such upheavals bring increased uncertainty about the future, making macroeconomic forecasting more challenging. In this post, we assess the forecasting performance of a state of the art empirical model, of the type commonly employed in academic research and policy institutions. This model is not used to produce the Monetary Policy Committee’s (MPC’s) forecast but has been used periodically within the Bank of England including as a cross-check to the main forecast. Specifically, we assess its performance in predicting UK inflation out of-sample at key dates around the start of the war in Ukraine. The model performs well in forecasting short-term inflation, but it struggles to fully capture inflation persistence over the longer term.