The Treasury’s independent economic forecaster has admitted it underestimated the scale of the inflation shock sparked by the Covid pandemic and Russia’s invasion of Ukraine.
Blaming the rapid succession of shocks hitting the economy, the Office for Budget Responsibility said it “significantly underestimated the strength and persistence of inflation”.
It also found corporate profits had been significantly stronger than expected in the past two years, including a 50% increase in finance industry profits fuelled by a boom in the banking industry, rather than the 13% rise it had anticipated.
In its annual forecasting evaluation report, the OBR said it had made some “genuine errors”, but that many of the differences between its predictions and the outcomes for the economy had been difficult to anticipate.
“To a significant extent these differences between outturns and previous forecasts are inevitable given the inherent difficulty in forecasting the path of the economy and the consequent effect on the public finances, which has been amplified recently by unforecastable shocks that hit the economy.”
The OBR has faced a barrage of criticism for its forecasting record from MPs, particularly from rightwing Conservatives who had sought to curb the watchdog’s influence under Liz Truss’s short-lived premiership.
Evaluating its March 2021 and March 2022 forecasts for the 2022-23 financial year, the OBR defended its record by saying its judgments were made before the invasion of Ukraine, while last year’s estimates came before the full impact of the conflict could be quantified.
It also said it had underestimated how damaging rocketing energy prices could be for the UK economy, while arguing Bank of England interest rate increases had taken longer than expected to counter the inflationary fallout.
The indirect effect of the energy shock feeding through to other prices – including food and other goods – had been almost twice as large as its initial estimate, the OBR said, after it made incorrect assumptions about changes in the UK economy since the 1970s that could have helped limit the impact.
Although there had been a decline in the overall energy intensity of the economy in the past 50 years and the structure of the Labour market had changed, the impact was compounded by the gas price surge coming on top of disruption from Covid supply bottlenecks in global trade. A labour shortfall after the pandemic had also helped workers to negotiate higher wage settlements than anticipated.
The OBR said it would revisit its assessments in its next forecasts, which will be published alongside next month’s autumn statement and used by the chancellor, Jeremy Hunt, to inform the government’s tax and spending plans.
Inflation peaked at 11.1% in October 2022, the highest level for more than 40 years, with an annual average of more than 8 percentage points higher than the OBR had anticipated two years ago.
While its March 2022 forecast factored in some of the pressure on energy prices from the Russian invasion of Ukraine, it still expected a significantly lower inflation peak of 8.7%.
Alongside higher inflation, the OBR said it had underestimated government borrowing, as higher government spending on cost of living support outweighed a rise in tax receipts from more resilient household spending, wage growth, and company profits.
Highlighting the unexpected strength of corporate profits, it said non-oil and non-financial company profits had risen by 7.3% in 2022, against predictions for a fall of 1.4% assumed in its March 2022 forecast.
Banks in particular benefited from a rise in their net interest margins, the OBR said, reflecting gains from rising Bank of England interest rates on the difference between the interest lenders charge on loans and deposits.
