Another backhand volley from forward guidance
While it’s a favourite game of every punter who’s not paid to make predictions to trash the track record of those who are, just about everyone who follows the European Central Bank was stunned by the timing of its decision to cut rates on Thursday.
In the days beforehand, a handful of forecasters began speculating after news of a collapse in inflation that the ECB might fire what could be their last shot on standard monetary policy using interest rates in a long time.
But the vast majority were caught off guard by the ECB’s refinancing rate cut to a record low of 0.25 percent. Even those who thought it might do so didn’t think it would until December. The quick, violent fall in the euro showed it.
The most puzzling bit is that this “surprise” move – as it is billed by nearly everyone writing about it – came only months after President Mario Draghi joined other central bank colleagues in announcing “forward guidance.”
That is a policy (which rather suspiciously was drawn up in haste after there was hardly anything in the way of interest rates left to cut) that surely has droves more people scratching their heads about what the point of it is now.
Forward guidance, obviously by the redundancy of the term, is designed to smooth out variances in opinion in where policy is headed and, in so doing, keep financial markets calm and priced more or less how the central banks wants them to be.
Reuters polls are a great gauge of that range of opinion, whether or not they match up with reality. Indeed, the monthly ECB poll taken the week before the ECB’s decision showed not one of 73 economists expected a November rate cut.
That seems an indictment of forward guidance if you judge success or failure by whether or not you have opinions of those who forecast where policy is going broadly lined up with where you are taking it.
The ECB has been one of the most predictable central banks in the world measured by the Reuters poll since the bank’s creation in 1999. Ironically, the “surprise” on Thursday by that measure was the biggest in history.
Some argue that taking risks with credibility on forward guidance is worth it if you get the desired effect – to bring market interest rates or the exchange rate down and stimulate the euro zone economy, which let’s not forget is still struggling.
But even on that measure, it’s tough to score a success of breaking a surprise out of a policy designed to bore.
Lena Komileva at G+ Economics notes:
“All in all, the ECB’s surprise rate cut has had a marginal impact on current market rates and its front-loaded effects on futures contracts at the more significant back-end of the money market curve have already started to fade.”
Can it be a surprise that since the U.S. Federal Reserve adopted forward guidance it issued the biggest policy shock in years by deciding not to cut back on its $85 billion in monthly bond purchases in September?
And should the rampant speculation over British interest rates be shocking since the Bank of England told us, based on its outlook for unemployment, that it would not likely consider an interest rate rise until 2016?
Central bankers talk a lot about what they might have done in hindsight in explaining where policy went wrong. But hindsight is an awkward thing to address when everything is supposed to be clear and forward-looking.