MNI POLICY: BOE's New Scenarios Risk Clouding Rate Message
MNI (LONDON) - Members of the Bank of England’s Monetary Policy Committee have begun spelling out their policy preferences in relation to alternative economic scenarios in line with recommendations by former Fed chief Ben Bernanke, but the recent experience of Governor Andrew Bailey shows the approach has its pitfalls.
In his review published in April, Bernanke recommended that the Bank de-emphasise its central forecast and place more emphasis on spelling out how policy might need to vary in different scenarios. The thinking behind this was to better inform the public and investors of how the BOE takes account of uncertainty, following heavy criticism of its slow response to commodity- and supply-side-driven inflation.
The BOE accordingly spelt out three broad scenarios in its September statement. The first outlines how unwinding global shocks could allow inflation to fade with a less restrictive monetary stance than in other cases, while in a second a period of economic slack is required to ease price pressures. In the third, structural shifts would require monetary policy to remain tighter for longer.
But the first major communications outings for this new approach have been bumpy, with both a local and national newspaper interviewing Bailey without making any clear reference to the scenarios while quoting him giving different views on the path of interest rates. One paper cited him saying he could be “a bit more aggressive” with rate cuts if inflation continued to come down, while the other stressed his view that the path downward for rates would only be gradual.
PILL SPEECH
The apparent dovish shift in the “bit more aggressive” interview sent the pound lower until Chief Economist Huw Pill gave a speech the next day in which he made clear that of the three scenarios he saw that for gradual easing as most likely. He added that he placed some weight also on the scenario under which rates remain high for longer, though he did not subscribe fully to any of them.
Independent member Megan Greene gave a similar view in a speech, preferring the gradual scenario but seeing some risk that easing might have to be removed only slowly.
Such nuances, however, risk being lost in media interviews, where the emphasis is often on soundbites or readability.
The three cases set out by the MPC also look more like outlines than the fully-fledged alternative scenarios. They will not wholly reflect members' thinking, creating risks for analysts scanning for clues ahead of the next policy vote. (See MNI POLICY: Cracks On MPC But Gradualism Holds)
MPC VIEWS
The views of other members of the MPC can also be placed in the context of the scenarios. Swati Dhingra seemingly backs scenario one, Catherine Mann is largely three with a switch to one possible once she believes tight policy has done its work, and Deputy Governor Dave Ramsden’s previous comments indicate a tilt towards one, although his views need to be updated. There are unknowns, with new member Alan Taylor yet to declare his hand.
While the Bank adopted all 12 of the Bernanke Review’s recommendations into its forecasting processes and communication, it will be a long haul to fully implement its call for a thorough overhaul of its forecasting framework, given the shortcomings of its IT and stretched staffing. This would require updating its information technology and implementing challenging improvements, such as incorporating "rich and institutionally realistic representations of the monetary transmission mechanism", as well as ditching the assumption that inflation expectations eventually return to target.
The Bank has said it will review progress on Bernanke before the end of the year, with Deputy Governor Clare Lombardellli spearheading the work. (See MNI POLICY: Time Needed For BOE To Make Bernanke Changes)