By David Milliken
LONDON – The Bank of England is rethinking how it signals what its next monetary policy steps are likely to be, after a bruising misunderstanding this month when it dashed market expectations of an interest rate rise.
New chief economist Huw Pill has said he intends to ‘train’ central bank watchers to improve understanding of the BoE, while Governor Andrew Bailey suggested saying less may be the answer.
Economists say they don’t want to be spoon-fed signals about when the BoE will raise rates – but they do need a clear sense of the relative importance it places on different data, especially with inflation recently hitting a 10-year high.
“There has been a considerable degree of confusion over what the bank has been signalling or not signalling,” said Philip Shaw, chief economist at Investec. “Less confusion would be better for everybody.”
The BoE is widely expected to be the first of the world’s major central banks to raise interest rates, as Britain faces widespread supply-chain difficulties and a buoyant job market as it emerges from the COVID-19 pandemic.
But on Nov. 4 the BoE kept its key interest rate on hold at 0.1%, sharply at odds with wider financial market pricing that saw a nearly 100% chance of a rise to 0.25%, although in line with a narrow majority of economists in a Reuters poll.
The market reaction was immediate and extreme. Sterling suffered its biggest daily fall against the dollar in more than 18 months, and two-year bond yields dropped more than on the day of the shock result of the June 2016 Brexit referendum.
No BoE policymaker had said explicitly that rates would rise in November, but financial markets had viewed comments from Bailey and Pill as implying they would.
Bailey said nL1N2RD07B on Oct. 17 that he was signalling to markets that the BoE would have to act if it saw a threat to medium-term inflation expectations, while Pill described nL8N2R32GM November as a “finely balanced” meeting for a rate rise.
In the event, both opted to wait for more data on the impact of the end of the government’s job-protecting furlough programme, and the Monetary Policy Committee voted 7-2 to leave rates unchanged.
Pill, a former chief European economist at Goldman Sachs, said last week that recent events had shown a lack of common understanding between the BoE, markets and media.
“What I’d like to do, which is a little bit patronising maybe to say, but which I’ll say anyway … is that we’re trying to train people to think the right way through policy,” he told an economics conference.
“Some volatility in that environment is inevitable. But what I hope is that we take a bit of that cost upfront, and I think we have,” he added.
Bailey said he might scale back guidance, adding that fully explaining the BoE’s world view – and its implications for interest rates – risked misunderstandings while economic data and the BoE’s own assessments were fluid.
“There is an alternative view, which is we should go meeting by meeting and not give any guidance,” he told lawmakers on Tuesday. “That is very well trodden ground by the MPC and I could imagine us going back to that.”
Jonathan Haskel, an external MPC member, said this week that it was better to communicate the medium-term outlook for policy than the “minute-by-minute, month-by-month outlook for rates”.
If the BoE is trying to teach market participants that no interest rate decision is a certainty, that message has struggled to get through.
At the start of the week, markets still priced a near 100% chance of rates rising to 0.25% on Dec. 16, after the MPC’s next meeting, though on Friday that dropped below 60%, largely due to news of a possible new COVID-19 variant.
Craig Inches, head of rates and cash at Royal London Asset Management, predicted more market turmoil if rates do not rise as expected, especially in thin and choppy year-end trade.
“It’s a bit of a stress point which the BoE should be aware of,” he said.
From his perspective, uncertainty about Britain’s job market and COVID-19 would justify delaying a rate rise until February.
Last month the BoE ended policymakers’ off-record briefings nL1N2R91SU to big financial firms, which previously were seen as a tool to better understand markets and reinforce policy messages but faced criticism for their lack of transparency.
The BoE is far from the only central bank to have been misread by markets.
In 2013 the U.S. Federal Reserve set off a so-called ‘taper tantrum’ that raised borrowing costs globally when it started to trim stimulus. And early in the pandemic in 2020, European Central Bank President Christine Lagarde rowed back on her comments that she did not aim to manage bond yield spreads.
Both central banks learned from the experience and refined their communication, economists say.
Few economists seek a return to the rigid forward guidance pioneered at the BoE in 2013 by Bailey’s predecessor, Mark Carney. That aimed to allay concerns the BoE would hurt the economy’s recovery but it had to be revised frequently due to a steady drop in the unemployment rate which it was pinned to.
But excessive vagueness would bring its own problems, especially as the BoE’s own economic forecasts use market interest rate expectations as a key input, Investec’s Shaw said.
“Markets should be free to make up their own minds without being spoon-fed. But at the other extreme, I think it would be wrong for a central bank not to give markets a good impression of what it was thinking, and perhaps a steer towards its intentions too,” he said.