MNI INSIGHT (RPT): BOE Guidance Underplays Tightening Bias

(Repeats article first published on May 25)

The Bank of England's current guidance underplays the commitment of the majority of the Monetary Policy Committee to further raising interest rates to contain inflation.

While the guidance in May’s statement states only that “most members of the Committee judge that some degree of further tightening in monetary policy may still be appropriate in the coming months,” recent comments by members suggest that the centre of gravity on the MPC tilts more firmly towards more hikes.

The current wording was watered down from a firmer commitment to higher rates in earlier statements, and now seems to be a compromise which reflects the views of no one on the nine-person Committee at all.

May’s MPC minutes show that some members, now known to have been two in number, dissented from the guidance despite voting in favour of that month’s 25-basis-point hike because “the risks around activity and inflation over the policy horizon were more evenly balanced.” The wording was however backed by the three members who had argued for a steeper 50-basis-point increase in Bank Rate, leaving them with unfinished tightening business at the June meeting.

"FURTHER TO RUN"

The Bank’s chief economist, Huw Pill, one of the majority who voted for a 25-basis-point hike, was clear about his own view on Friday, saying that he wanted “to signal today that this tightening still has further to run.”

Deputy Governor Dave Ramsden sent a similar message in comments to the Treasury Select Committee on May 16, telling lawmakers that “our current guidance … is that most of the members of the Committee think that further tightening in policy will be required,” a blunter version of the MPC’s agreed language.

No MPC member has used the guidance in full to communicate the policy outlook, highlighting its limitations.

But, while the guidance may reflect only a hollow middle of the MPC’s views, replacing it would not be easy.

With the MPC divided as growth slows and recession risks rise even as inflation moves towards double digits, anything but the blandest of guidance risks a prompt obsolescence.

Scrapping the guidance would also be risky, with the market likely to misinterpret a removal of the reference to further tightening as dovish.

BAILEY NO FAN OF GUIDANCE

Governor Andrew Bailey, unlike his predecessor Mark Carney but like his chief economist, is not enthusiastic about forward guidance as a policy tool, particularly when upside and downside risks abound. (See MNI INSIGHT: BOE On Tightening Path Without Forward GuidanceGuidance)

Speaking at an Austrian National Bank seminar Monday, Bailey said in unscripted remarks, “we are in a world of unusually high uncertainty … We have to be pretty cautious about how we can use forward guidance without getting ourselves into a situation where we have to take it away, reverse it.”

Such unpredictable conditions are also making it more difficult for the Bank to form a judgement of the likely ending point of this interest rate cycle. Uncertainties around the level of the neutral rate of interest, compatible with stable levels of inflation and output, are being magnified by changes in the post-Covid labour market, complicating calculations of the neutral rate of unemployment.