Forecast Rationality and Monetary Policy Frameworks: Evidence from UK Interest Rate Forecasts

This paper explores the heterogeneity and rationality of professional forecasts at both short and long forecast horizons. We employ disaggregated survey data for forecasts of three-month inter-bank rates and ten-year gilt yields for the period 1989-2006. We find evidence of heterogeneity among forecasters. Moreover, forecasts violate both the unbiasedness and orthogonality conditions of the rational expectations hypothesis. The majority of biased forecasts underestimate the future spot rate. The rationality of forecasts varies across maturities and forecast horizons with short horizon and short maturity forecasts exhibiting more rationality. It also varies across sub-periods corresponding to different monetary policy frameworks. We produce evidence indicating that both monetary policy actions and elements of communication policy have information content regarding the rationality of forecasts. Changes in official bank rates and disagreement, as recorded in the minutes of the Monetary Policy Committee, influence the rationality of forecasts. The publication of inflation reports has no effect.