MNI INSIGHT: BOE On Tightening Path Without Forward Guidance

The next hike in UK interest rates looks set to be delivered without any official steer as to timing or to the precise conditions to be met to justify tightening, following the Bank of England’s decision to move away from explicit forward guidance.

The Monetary Policy Committee’s prior conditional guidance that it did not intend to tighten without “clear evidence that significant progress is being made in eliminating spare capacity” was ditched in September. Then in December, when the MPC delivered a 15-basis point hike, it also dropped November’s guidance, which had stated that if incoming data, particularly on the labour market, were broadly as expected it would be necessary to boost rates over coming months.

The Bank’s experience with guidance has often been an unhappy one, earning it the moniker “unreliable boyfriend”. New BOE Chief Economist Huw Pill has now expressed his unease over even conditional forward guidance, saying that such policy forays tend to end in confusion.

While the BOE still retains some guidance, that "modest tightening of monetary policy over the (three-year) forecast period is likely to be necessary”, it is vague enough to impose no real constraint on policy setting, allowing freedom over the timing and scale of hikes.

NO TURNING BACK TO GUIDANCE

And nor is the Bank likely to return to firmer guidance in the future. For example, in the case of fresh economic disruption from something such as new Covid shocks, it is unlikely to try to reassure markets with a promise to keep rates lower for longer, a commitment which might put it in the position of having to look through periods of overshooting inflation, contravening its mandate.

Markets are still getting used to the move away from what Deputy Governor Ben Broadbent has scornfully described as the “spoon-feeding” of investors. With asset prices volatile, MPC members have become wary of providing commentary that could be interpreted as steering for a hike in any given month, and markets were wrong-footed by December’s hike, which they had not expected until February. Investors had made an incorrect collective punt in the opposite direction in November, when they had mistakenly expected a rate increase.

The MPC also looks unlikely to become much more specific about how high Bank Rate is likely to rise this cycle. While one MPC member, Silvana Tenreyro, has referred to a return to around the pre-Covid level of Bank Rate of 0.75%, the Committee publishes neither individual nor collective rate forecasts, so it has no straightforward way of signalling where it expects them to peak.

Investors will try to read a rate path into projections in the Monetary Policy Report, which in November indicted that if Bank Rate rose in line with market expectations to around 1.1%, inflation would undershoot the 2.0% target three years out. However, as former MPC member Gertjan Vlieghe has explained, multiple rate paths are compatible with bringing inflation back to target, and it is not possible to back out a unique MPC-desired path for interest rates simply by observing how far the inflation forecast is above or below target at the end of the forecast period. New projections come in February.