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28 Dec 2015
BoE: In search of new guidance – RBS
FXStreet (Delhi) – Ross Walker, Senior UK Economist at RBS, notes that 2015 marked another year where market participants struggled with the BoE’s communication.
Key Quotes
“This may in part reflect the problem of the Bank’s rather diverse audiences – ramming home warnings to households about the possibility of Bank Rate rises inevitably risks fuelling excessively ‘hawkish’ expectations among market participants (though, once again, City economists have generally been off-side whereas financial market pricing retained a more consistently dovish bias).”
“The BoE’s existing policy guidance centres on the notion that some spare capacity persists (primarily in the labour market) and that above-trend growth is required to eliminate it in order to push CPI inflation back up to target. The MPC has, on several occasions, pushed back against what it regards as excessively dovish market pricing – repeated Inflation Report forecasts showing CPI overshooting its target based on market rates and expressions of puzzlement at the ‘exceptionally flat’ yield curve.”
“There would appear to be one of two ways to rectify this: the BoE actually raises rates ahead of market expectations, shunting markets into pricing a different trajectory for monetary policy, or the BoE amends its policy framework, ditching the ‘spare capacity’ framework and instead focusing on the maturity and security of the recovery (ie, a clearer statement that rates are simply at the wrong level for a maturing, and still secure, recovery).”
“Neither outcome seems very likely to us, hence policymaker communication guiding markets towards Bank Rate hikes is likely to continue to cause confusion across the City. The more politicised backdrop (the Brexit referendum and contentious fiscal tightening) will not make the Bank’s communication effort any easier.”
Key Quotes
“This may in part reflect the problem of the Bank’s rather diverse audiences – ramming home warnings to households about the possibility of Bank Rate rises inevitably risks fuelling excessively ‘hawkish’ expectations among market participants (though, once again, City economists have generally been off-side whereas financial market pricing retained a more consistently dovish bias).”
“The BoE’s existing policy guidance centres on the notion that some spare capacity persists (primarily in the labour market) and that above-trend growth is required to eliminate it in order to push CPI inflation back up to target. The MPC has, on several occasions, pushed back against what it regards as excessively dovish market pricing – repeated Inflation Report forecasts showing CPI overshooting its target based on market rates and expressions of puzzlement at the ‘exceptionally flat’ yield curve.”
“There would appear to be one of two ways to rectify this: the BoE actually raises rates ahead of market expectations, shunting markets into pricing a different trajectory for monetary policy, or the BoE amends its policy framework, ditching the ‘spare capacity’ framework and instead focusing on the maturity and security of the recovery (ie, a clearer statement that rates are simply at the wrong level for a maturing, and still secure, recovery).”
“Neither outcome seems very likely to us, hence policymaker communication guiding markets towards Bank Rate hikes is likely to continue to cause confusion across the City. The more politicised backdrop (the Brexit referendum and contentious fiscal tightening) will not make the Bank’s communication effort any easier.”