How accurate are the inflation forecasts published by the commercial banks?

Abstract

The paper evaluates monthly inflation forecasts of four financial entities during the period 2000 to 2006. Most of the forecasts show similar results with inflation forecasts 2 to 6 points under the actual change in inflation each month. There is no statistical difference in the quality of forecasts between periods, that is a good forecast in one month does not imply a good forecast in the following month. In the beginning of each month during the research period each financial entity published a forecast of inflation for that month, while Statistics Iceland would publish the official inflation figure around the 10th day of the month. Icelandic bonds are linked to inflation and during the ten day period before the official inflation figure is published, the index used was the Central Bank‘s quarterly forecast smoothed over three months. This paper examines whether there is arbitrage opportunity in using the inflation forecasts in bond transactions. Although the monthly inflation forecasts are usually better than the smoothed Central Bank‘s quarterly forecasts, arbitrage opportunities are slim due to transactions costs.