Forecasting UK Inflation: An Empirical AnalysisÂ

Seth Armitage and Janusz Brzeszczynski

No 1002, CFI Discussion Papers from Centre for Finance and Investment, Heriot Watt University

Abstract: This paper considers different ways of forecasting UK RPI inflation. We show that the inflation risk premium on nominal gilts and inflation swaps vary significantly over time. The average inflation risk premia on both of these market instruments have increased considerably since 2004 and during this time the term structure of the inflation risk premium has changed from flat to upward sloping. The econometric model designed for this study is found to produce more accurate inflation forecasts than market break-even inflation rates and surveys by Consensus Economics. However, the evidence suggests that the best approach to forecasting inflation combines forward-looking and historical methods.

Date: 2010
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