Insight: BOE Can't Re-use 'Murky' Guidance To Shift Markets

By David Robinson

     LONDON (MNI) - The Bank of England Monetary Policy Committee's attempt to

get financial markets to price-in more tightening fell flat at its August

meeting and the debate is open over how to make its messaging more effective in

coming months.

     MNI spoke to market participants, analysts and people familiar with the

Bank's thinking. There was agreement that the imprecise message the MPC

delivered in August had been very hard for markets to re-act to but the catch is

that with the committee split over the need for near-term tightening it will be

challenging for it to come up with anything more specific at its upcoming

meetings.

     At the August meeting the MPC voted six-to-two in favour of unchanged

policy and offered no agreed line on near-term tightening and the accompanying

Inflation Report forecasts for growth and inflation were little changed. Around

a third of analysts had predicted three votes in support of a hike, and the

initial market response, part-driven by algorithmic trades, was to treat the

news as relatively dovish and to push sterling and yield curves lower.

     The minutes, however, contained a line that markets had been under-pricing

the amount of tightening required, stating that if things evolved as forecast

"then monetary policy could need to be tightened by a somewhat greater extent

over the forecast period than the path implied by the yield curve underlying the

August projections." 

     "Algos will respond to the outcome and minutes vote first. There was a

genuine need to price out the possibility of a hike at that meeting. What the

MPC said was never going to be enough to deliver a hawkish response. They said

they needed more tightening but didn't do what was necessary to see it

priced-in," Philip Rush, of economic consultancy Heteronomics, said.

     The esoteric approach to central bank guidance is to classify it as Delphic

or Odyssean. As ECB Executive Board member Benoit Coeure set it out in a speech

in March. Delphic guidance relies on the central bank forecast of how the

economy will likely evolve, while Odyssean guidance "relates what we think will

happen to what we will do if it happens."

     The MPC's August line on the likelihood that the market was under-pricing

tightening is "a bit of both. The Delphic bit is 'if the world turns out how we

think it will, then our future behaviour, which we want to reveal/clarify, means

that interest rates will follow a path like x.' The Odyssean bit is that once

this promise has been made, there will be a cost to pay if rates don't follow

x," said Tony Yates, an academic and formerly a senior figure in the BOE's

directorate devoted to monetary policy.

     The frustration for traders who were looking for anything supportive of

tightening was the statement's lack of specificity about when and by how much

Bank Rate might need to rise. As one strategist noted, with nothing offered on

near-term tightening it was an impossible task on the day to decide where to try

and push yield curves higher.

     "Although the MPC doesn't have the job of making trades easy, I sympathise,

since there is no good reason ... why this more specific guidance should not be

given," Yates said.

     Yates said that "in general the context is one in which MPC announcements

are unnecessarily murky."

     Unlike the US Federal Reserve, the BOE has decided against providing

individual interest rate forecasts for voting members. 

     Instead the Inflation Report forecasts are the best collective judgement of

the MPC, essentially whichever forecast they can sign-off, based on market

rates. After signing-off on the quarterly forecasts, members thrash out a form

of words for the Monetary Policy Summary part of the minutes.

     Ahead of the publication on August 3 of the minutes and policy decision,

markets were focussed on the vote, with opinions split over whether BOE Chief

Economist Andrew Haldane would join Ian McCafferty and Michael Saunders, in

backing a hike and whether the MPC would say something concrete on the

likelihood in coming months of raising Bank Rate.

     The initial wire headlines and BOE twitter feed announced the unchanged

policy decision and revealed that there were only two votes for a hike. The

BOE's website froze as the midday announcement came through, with any economists

and strategists who were looking to access the detailed text of the policy

statement temporarily blindsided. 

     At the subsequent press conference, to the annoyance of traders looking for

a hawkish line, BOE Governor Mark Carney ducked saying anything of substance on

the likely timing of the first hike.

     Asked if thought that "the curve is currently underestimating the timing of

the first hike" Carney replied "I don't think it's appropriate for me to tie the

hands of the Committee by expanding on our view as a Committee, particularly

with respect to timing."

     One problem for Carney and his colleagues is that with the MPC split over

the need for near-term tightening, agreeing any specific guidance is knotty.

Among the issues the committee members weigh is whether the costs of hiking too

early are greater than hiking too late, how substantial the cost of a policy

reversal would be and what the credibility cost would be of once again raising

the possibility of a near-term hike only to pull back.

     Gertjan Vlieghe is one MPC member who is very wary of hiking near-term,

saying in an interview with the Independent published July 3 that "this is an

environment where a premature hike would be a bigger mistake than one that turns

out to be slightly late because of the asymmetry around risk."

     Silvana Tenreyro only attended her first meeting in August. It would be

understandable if she wants time before signing up to guidance on a near-term

hike.

     Carney himself faces concerns about credibility problem as his previous,

albeit explicitly conditional, steers on when a rate hike could come have never

resulted in any actual tightening.

     At the MPC's next meeting, decision expected September 14, and at the

subsequent November one, Carney and his colleagues will again have to decide if

they want to try and agree on a more effective steer to markets than in August.

     The most straightforward option to push market rate expectations higher

would be for one, or more, further members to vote for a hike as agreement on

any more specific guidance may prove elusive. With the data showing that while

inflation is running above target the economy is slowing and pay growth is

subdued, MPC members are unlikely to be queuing up to take the plunge and vote

for a hike.

     Whether the MPC choses to repeat its August line that "monetary policy

could need to be tightened by a somewhat greater extent over the forecast period

than the path implied by the yield curve," would be a sideshow unless there

something more concrete to flesh it out.

     More trivially, the Bank is set to upgrade its website, with the new

version hopefully immune to freezing - which would at least allow analysts to

study whatever words the MPC does agree on straight after the policy

announcement is made.

     The first 25 Bank Rate hike, lifting it from 0.25% to 0.5%, is only fully

priced-in on OIS rates in around 24 months' time, later than before the

Inflation Report was released and with the curve rising at only a glacial pace

from there. If the MPC had hoped to drive the curve higher, its communication in

August appears to have failed to do the job.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MX$$$$,M$$BE$]