One way to tackle the Bank of England’s communication problem
The writer is director of European fixed income strategy at Barclays
There are lessons to learn for both the Bank of England and the market after the central bank dashed expectations by not delivering a tightening in its main policy rate at its meeting last week.
In a world of greater data volatility, investors may have to live with more surprises, and reconsider how they interpret messages from members of the policy-setting Monetary Policy Committee. For the BoE’s part, it seems smart to revisit its communication strategy to aid the market’s understanding.
On the eve of the meeting last Thursday, investors had priced a full 0.15 percentage point increase in the bank’s benchmark rate to 0.25 per cent. This was quite the turnround considering that at the previous two meetings of the MPC, the market had priced only about 0.01 points of tightening for November.
The market’s surprise over the BoE’s decision was evident in its aftermath: policy-sensitive two- and five-year gilts rallied sharply with yields falling by 0.20 percentage points by early evening. That was the largest intra-day move in five-year yields since the EU referendum. Expectations in tightening have now been pushed back and the peak in rates in the current cycle lowered by around 0.20 percentage points.
The gyrations of gilt yields should not really be a big factor in policy deliberations. But their volatility highlights a wider problem — a communication impasse between the Bank and the market.
In the run-up to last week’s meeting, a succession of MPC speakers had emphasised the need to tighten policy in order to head off the risk of what they viewed as largely transitory inflation becoming embedded into wider expectations. In response, the market adjusted the pricing of short-term rates in anticipation of a sharper and faster tightening cycle.
The MPC, in its defence, will point towards the conditionality that it attaches to all its statements. The BoE’s policy stance is constantly adjusted within the framework of meeting its inflation mandate. Equally, the central bank is not solely responsible for the evolution of market pricing, which can reflect myriad external factors.
But the result is a comedy of errors. The MPC could claim that the market misread its messages, while the market would say that the committee lacked clarity in its communications.
Traders and analysts, no doubt aggrieved at being wrong, could also argue that the committee had ample opportunity to reshape market pricing ahead of last week’s meeting. Both sides should now adjust their expectations. But the kind of outcome we saw last week is not without cost: volatile markets degrade both the signal and the process of monetary policy. Extreme cases might diminish the BoE’s credibility.
Communication remains an important tool in any central bank’s armoury, and all the more so as we leave an era of asset purchases by them to support markets. Through speeches and interviews, MPC members play crucial roles in steering market rates, which remain a key input in the construction of the BoE’s own inflation forecasts, delivered every quarter.
The central bank has traditionally used those forecasts to guide investors’ expectations. If inflation at the two-year horizon is above the BoE’s 2 per cent target, the market is effectively being asked to price more tightening; lower, and the opposite is true. Such sphinx-like communication may (sometimes) be clear to dedicated BoE watchers, but not to broader audiences.
The MPC is wide-ranging by design: it was set up to offer a plurality of views, with each member responsible and accountable for their own vote. And it is true that the BoE has taken steps to improve understanding of the committee’s deliberations, regularly publishing minutes including splits on votes, for example, while providing other documents to illuminate members’ thinking.
But looking ahead, it might consider going further. Former MPC member Gertjan Vlieghe offered a possible way forward in a speech two years ago. He noted that the MPC publishes a forecast of what it thinks is likely to happen to growth and inflation given a path of interest rates determined by the market.
It would be better, he said, for the MPC to simply follow the lead of other central banks and publish members’ own projections of the likely path of rates. “If we want people to understand what we, the MPC, think is the necessary path of interest rates to achieve the inflation target, why not just tell them?” he asked.
If we are moving to a world where monetary policy will be conducted against a backdrop of higher uncertainty, why not indeed.