An Analysis of UK Households’ Directional Forecasts of Interest Rates

Abstract

In this paper, we evaluate the directional interest-rate forecasts of UK households from the Bank of England’s Inflation Attitudes Survey. Employing a test for directional forecast accuracy and data on the survey balance ranging from 1999Q4 to 2023Q2, we find that the balance is not able to predict in which direction the interest rate will move over the coming year. In addition, regression models based on the balance are not able to generate forecasts for the quantitative change in the interest rate over the coming twelve months that have higher precision than a naïve forecast of no change. In order to provide information as to whether our findings are due to the inherent difficulty when it comes to forecasting interest rates or if households are not very insightful regarding interest rates, we investigate – again using data on the survey balance and testing for directional accuracy – whether households have been able to correctly assess the directional change of the interest rate over the previous twelve months; our results indicate some amount of “literacy” among the households regarding the interest rates that they face. Finally, analyses based on individual-response level data suggest that literacy regarding interest rates – proxied by the respondent having been correct regarding the directional change over the previous twelve months – does not appear helpful when forecasting.