- Markets confused by BoE signals ahead of November meeting
- Sterling and gilt yields fell after the bank rate was unchanged
- BoE’s Pill says it wants to “train” the markets to better understand them
- Governor Bailey sees arguments for less guidance
- Investors continue to expect the BoE to hike rates in December
LONDON, Nov 26 (Reuters) – The Bank of England is considering how to signal its likely next monetary policy moves after breaking market expectations of a rate hike earlier this month.
New chief economist Huw Pill said he intended to “train” central bank watchers to improve understanding of the BoE, while Governor Andrew Bailey suggested saying less could be the answer.
Economists say they don’t want to give signals as to when the BoE will hike rates – but they need a clear awareness of the relative importance it attaches to different data, especially since inflation recently hit a 10-year high.
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“There has been a considerable amount of confusion as to what the bank has or has not signaled,” said Philip Shaw, Investec’s chief economist. “Less confusion would be better for everyone.”
The BoE is widely expected to be the first of the world’s major central banks to hike rates as the UK faces widespread supply chain difficulties and a buoyant job market following the COVID-19 pandemic.
But on Nov. 4, the BoE left its policy rate at 0.1%, in sharp contradiction to broader financial market prices, which saw a near 100% chance of rising to 0.25%, though by a narrow majority of them Economists agreed a Reuters poll.
The market reaction was immediate and extreme. The pound sterling suffered its largest daily decline against the dollar in more than 18 months, and two-year bond yields fell more sharply than on the day of the shock result of the Brexit referendum in June 2016.
No BoE policymaker had specifically said interest rates would rise in November, but financial markets had taken Bailey and Pill’s comments as implied.
Bailey said on Oct. 17 that he was signaling to markets that the BoE should act if it saw a threat to medium-term inflation expectations, while Pill described November as a “finely balanced” meeting for a rate hike.
In this case, both opted to wait for more data on the impact of the end of the government’s job-preserving vacation program and the Monetary Policy Committee voted 7-2 to leave the rates unchanged.
Pill, a former European chief economist at Goldman Sachs, said last week that recent events had shown a lack of common understanding between the BoE, the markets and the media.
“Which I would like to do, which is maybe a little condescending, but what I’ll say anyway… Business conference held.
“Some volatility in this environment is inevitable. But I hope that we will cover some of these costs upfront and I think we have,” he added.
Bailey said he could downgrade forecasts, adding that a full explanation of the BoE’s worldview – and its impact on interest rates – is fraught with misunderstandings while the economic data and the BoE’s own assessments are fluid.
“There is an alternative view, namely that we should go from session to session and not give guidance,” he told lawmakers on Tuesday. “This is very well-trodden territory for the MPC and I can imagine we will come back to it.”
Jonathan Haskel, an external MPC member, said this week that it is better to communicate the medium-term outlook for policy than the “minute and month outlook for interest rates.”
When the BoE tries to teach market participants that no rate decision is safe, that message has gotten tough.
At the start of the week, after the next MPC meeting on December 16, the markets were still pricing a near 100% chance that rates would rise to 0.25%, despite falling below 60% on Friday, largely due to news about a possible new COVID-19 variant.
Craig Inches, Head of Rates and Cash at Royal London Asset Management, predicted further market turmoil if rates don’t rise as expected, especially in thin and troubled year-end trading.
“It is a certain stress point that the BoE should be aware of,” he said.
In his view, the uncertainty over the UK labor market and COVID-19 would justify postponing a rate hike until February.
Last month, the BoE ended policy makers’ off-record briefings to major financial firms, previously seen as a tool to better understand markets and reinforce political messages, but criticized for their lack of transparency.
The BoE is far from the only central bank misinterpreted by the markets.
In 2013, the US Federal Reserve sparked what was known as a “taper tantrum,” which increased borrowing costs around the world when it began cutting incentives. And at the start of the pandemic in 2020, the President of the European Central Bank, Christine Lagarde, rowed back on her comments that she was not aiming to manage bond yield spreads.
Both central banks have learned from the experience and refined their communication, say economists.
Few economists are looking to return to the rigid forward guidance introduced at the BoE 2013 by Bailey’s predecessor, Mark Carney. This should allay concerns that the BoE could hurt economic recovery, but had to be revised frequently due to a steady decline in the unemployment rate to which it was pegged.
But excessive vagueness would create its own problems, especially since the BoE’s own economic projections use market rate expectations as an important input, Investec’s Shaw said.
“Markets should be free to form their own opinions without being led to believe. But at the other extreme, I think it is wrong for a central bank not to give the markets a good idea of what it is thinking, and maybe even control “its intentions,” he said.
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Additional coverage from Sujata Rao; Edited by William Schomberg and Emelia Sithole-Matarise
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