It has often been said that the best central bankers tend to be boring. That was just another away to emphasise the centrality of communication as one of their most important tools in guiding markets. The less surprising — and therefore disruptive — policy was, the better.
This has changed since the outbreak of the global financial crisis from about 2007, with central bankers having to devise new tools and instruments to deal with conditions that were previously unimaginable. Central banking has since then been defined by breaking taboos, including the introduction of negative interest rates and quantitative easing to deal with low inflation and the possibility of deflation.
With economies having opened up again after the Covid-19 shock of 2020 and supply chains slow to catch up, central banks are facing the old enemy again, and have been confronted by a dilemma about the timing of interest rate increases with inflation in many developed economies running twice as fast as official targets. In the meantime, recoveries are not yet secure, and central banks face a risk of killing them off by tightening policy too soon and too aggressively. So these times are far from boring.
The governor of the Bank of England (BoE) Andrew Bailey still raised eyebrows when he said it was not his job to steer market expectations of interest rates after the UK policymakers shocked markets by keeping rates unchanged.
The decision was preceded by hawkish comments by Bailey that policymakers would have to act on inflation, which they forecast will climb to more than twice its target of 2%. Markets proceeded then to price in a rate hike in the November 4 meeting, and reacted sharply when it didn’t come. The governor came in for heavy criticism, so much so he felt the need to hit the airwaves.
What irked traders wasn’t so much the decision, but that the central bank didn’t correct them when they had come to the conclusion that a rate hike was a fait accompli. “I don’t think it’s our job to steer markets day by day and week by week,” Bailey told Bloomberg TV.
People who followed BoE policy when Mervyn King was in the hot seat will remember that he tolerated inflation to stay well above target during the “Great Recession” about a decade ago. But he consistently made it clear he wouldn’t move on rates and that he was confident inflation would slow.
In this case central bank credibility has suffered from a perceived failure to match words with action. Credible forward guidance from the central bank is vital in driving the actions of players in the markets and ensuring confidence in the economy overall. Of course traders can take it too far and believe that the central bank’s role is to remove all risks by pre-announcing policy.
In January 2020 SA had a similar situation when Reserve Bank governor Lesetja Kganyago came in for criticism over a 25-basis point cut in the repo rate that analysts hadn’t expected. Instead of looking at their own forecasting abilities, they took aim at the Bank and accused it of mismanaging its communication.
The Bank’s next rates decision is due on November 18, and the communication so far, despite an acceleration in inflation, has emphasised policymakers’ confidence that the acceleration in inflation may be “transitory”. That’s even as the Bank’s model, and market pricing, has indicated for a while that the repo rate might start increasing in the fourth quarter of 2021.
Kganyago has even pointed recently to the heightened risk that “tapering” on the part of the US Federal Reserve will mean further rand depreciation, which could drive up inflation and that global supply chain issues will impact SA and its inflation trajectory too.
But SA’s policymakers have given little sign they are ready to move any time soon. If they have changed their mind, they don’t have much time to guide the market, and a hike next week would still come as a surprise, when boring is preferable.
The BoE’s experience is a timely demonstration of the dangers ahead if central banks don’t manage their communication on a new policy path effectively.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.