Followup comments on latest ECB and BOE decisions
Genevieve Signoret
We summarized the monetary policy decisions here. What follows are my comments.
What is forward guidance?
Forward guidance is a communication-based monetary policy lever through which a central bank tries to shape expectations as to the forward path of interest rates and, through either a calendar approach (“not until such-and-such-a-date will do we expect to raise rates”) or numerical thresholds (“not before unemployment falls to 6.5%”), diminish uncertainty around those expectations.
Note that a threshold is not a trigger.
ECB Governing Board communiqué
This most dovish communiqué, to our joy, violated our bleak assumption underlying all scenarios that the ECB would continue to perceive larger inflation risks than deflation risks.
Incoming information has confirmed our previous assessment. Underlying price pressures in the euro area are expected to remain subdued over the medium term. In keeping with this picture, monetary and, in particular, credit dynamics remain subdued. Inflation expectations for the euro area continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, recent confidence indicators based on survey data have shown some further improvement from low levels. Our monetary policy stance is geared towards maintaining the degree of monetary accommodation warranted by the outlook for price stability and promoting stable money market conditions. It thereby provides support to a recovery in economic activity later in the year and in 2014. Looking ahead, our monetary policy stance will remain accommodative for as long as necessary. The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics.
In our view, the unambiguously dovish tone, the apparent cure undergone by the ECB of its neurotic habit of seeing inflation behind every bush even in times of deflation risk, is a development just as important as the ECB’s first use of forward guidance.
We don’t mean to underplay the importance of that first use, however. It’s an effective way to manipulate expectations to depress yields.
JPMorgan on the ECB communiqué
Bruce Kasman in JPMorgan’s Global Data Watch (“Made in DM”, 5 July 2013) points out that the ECB communiqué, by signaling concern over rising global interest rates, lowers the bar for a rate cut. We agree.
Bank of England Monetary Policy Committee communiqué
The Bank of England’s publishes a communiqué only when it feels like it. It published one last week, its first under the leadership of its new governor, Mark Carney. This communiqué, like the ECB one, provides forward guidance for the first time:
The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.
It also mentions a forthcoming report to be published on the use of forward guidance as a monetary tool. Both the ECB and the BoE communiqués took a calendar approach to guidance. Some analysts speculate that the BoE study will sanction the use also of numerical thresholds.