1st February 2026
Not for the first time the British public was able to predict the latest inflation much more accurately than the Bank of England's policymakers. Costas Milas Professor of Finance at the University of Liverpool explains why and what the Bank should do about it.
Britain's Consumer Price Index inflation rose to 3.4 per cent in December 2025, up from 3.2 per cent in the previous month. For 2025Q4 it stood at 3.4 per cent. Inflation turned out to be much closer to the forecast of 3 per cent made by the public one year earlier than the Bank of England's (BoE) own forecast of 2.7 per cent.
And, astonishingly, even the public's forecast made two years earlier, of 2.8 per cent for 2025Q4, was more accurate than the BoE's own forecast of 1.9 per cent. Is this down to the public's good luck? Or, should we instead credit the wisdom of the crowds?
Public expectations of inflation in Britain are derived by the Bank of England's Inflation Attitudes Survey, a set of 24 questions (plus more sub-questions) asked to a sample of approximately 2,200 adults every three months.
Analysis published in May 2025 by the Financial Times's Alphaville columnist, Louis Ashworth, painfully went through the individual (anonymised) answers, and found that there was only one woman in Britain who we should trust to correctly predict inflation - a young Scottish female student they named Hannah.
Think of my analysis here regarding the wisdom of the crowds as aggregating the FT’s findings. Chart 1 explores this further. It plots actual inflation together with the one-year forecast of the BoE and one-year public expectations of inflation since 2006.
The public has over-predicted actual inflation by an annual average of only 0.1 percentage points (by 0.5 percentage points in terms of the median), whereas the BoE has under-predicted inflation by an annual average of 0.6 percentage points (by 0.3 percentage points in terms of the median).
Why opinions matter
Public expectations of inflation matter when setting interest rates. This is because higher expectations of inflation increase worker demands for higher wages and, consequently, put upward pressure on inflation.
To see this, consider an empirical model of inflation in terms of five economic drivers: (i) past inflation (namely a measure of inflation momentum or carry over effects), (ii) public expectations of inflation one-year ahead, (iii) excess demand in the economy, (iv) interest-rate setting decisions and (iv) the oil price. For excess demand I use the output gap (% deviation of GDP from its potential) measure of the Office for Budget Responsibility. According to economic theory, inflation is on the rise when output exceeds potential, whereas inflation retreats when output falls below potential.
For interest rates I rely on the Bank of England’s Bank Rate (and the model uses the four-quarter change in Bank Rate lagged one quarter). For oil effects I use the difference between the price of oil (transformed into sterling) and its two-year historical moving average.
Chart 3 plots actual inflation together with the model’s predicted inflation and the historical contributions of each economic driver implied by the model over the 1999-2025 period.
Chart 3 shows that inflation momentum is the main driver of inflation, followed by public expectations of inflation. The driving role of inflation momentum suggests that inflation might take time to return to the target. Excess demand in the economy, interest rate decisions and oil price movements contribute less to inflation movements (oil has had a notable contribution following Russia’s invasion of Ukraine in February 2022).
Notice that interest rate decisions contribute positively to inflation from 2024Q4 onwards. Interest rate hikes that began in 2021Q4 were partly reversed from 2024Q3 onwards. This raises the issue of whether the BoE abandoned its monetary tightening (too) early.
A counterargument is that past interest rates hikes were still suppressing inflation in 2025 through their suppressing impact on excess demand. Indeed, from Chart 3, excess demand was still putting downward pressure on inflation throughout 2025.
Consumers and firms are keen to have a good idea of where future interest rates might end up so that they can plan their spending and investment decisions. Since public expectations matter for inflation, the BoE’s quarterly Monetary Policy Report could discuss alternative future paths of the Bank Rate by taking into account not only its own inflation forecasts, but also public expectations of inflation or even a combination. So far, the BoE’s Monetary Policy Committee members (made up of a total of nine members - five from the Bank and four external members appointed by the Chancellor of the Exchequer) have resisted calls to report their own views on the future path of interest rates and report, instead, market expectations of interest rates that do not necessarily provide a good description of where future interest rates might end up.
Why not report then an interest rate path retrieved from the anonymised views of the public?
Note
This article was first published on the London School of Economics blog on 28 the January 2026.
Author - Costas Milas is Professor of Finance at the University of Liverpool.
To read it with lots of links and charts go HERE