Shock now clearly trumps transparency in central bank policymaking

January 29, 2014

The days of guided monetary policy, telegraphed by central banks and priced in by markets in advance, are probably coming to an end if recent decisions around the world are any guide.

From Turkey, which hiked its overnight lending rate by an astonishing 425 basis points in an emergency meeting on Tuesday, to India which delivered a surprise repo rate hike a day earlier, central banks are increasingly looking to “shock and awe” markets into submission with their policy decisions.

A wide sample of economists polled by Reuters on Monday already expected a massive rise of 225 basis points by Turkey’s central bank to stop a sell-off in the lira. Instead it doubled the consensus and opted for the highest forecast.

Gizem Oztok Altinsac, chief economist at Garanti Securities in Istanbul, who correctly called the size of the Turkish rate hike said:

I was expecting this kind of a move because Brazilian interest rates are at 11 percent and they (Turkey) have to give something close to that and maybe somewhat above.

Altinsac, however, is uncertain it will help stabilize the lira in the long-term, especially with money outflows from emerging markets expected to continue.

Michael Hewson, senior analyst at CMC Markets, agrees:

Certainly a bit of shock and awe on the rate hike but you do have to wonder, if this doesn’t work in arresting the decline in the lira, what other measures the Turkish central bank has? Do you jack up rates again? … My big concern is they start talking about capital controls.

For the Reserve Bank of India, the strong majority was for them to hold interest rates steady. Instead, they hiked.

Then South Africa joined its peers on Wednesday with a 50 basis point hike in the repo rate for the first time in nearly six years – also unexpected.

Last year, Indonesia and Japan stunned markets a few times last year by shifting monetary policy when least expected.

The U.S. Federal Reserve shocked financial markets and forecasters last September by holding off on what the vast majority thought was going to be the start of a widely-telegraphed intention to gradually taper its monthly bond purchases.

But it just kept on going, waiting until December to announce a $10 billion trim to its $85 billion per month purchase programme. That also took many off guard.

Even the European Central Bank, which came late to the forward guidance club last year, surprised markets in November with an interest rate cut after a plunge in inflation.

The Bank of England is also poised to rewrite its forward guidance barely half a year after its launch last August. The jobless rate, which the Bank said was key to guiding interest rate hike expectations, dipped to within a hair’s breadth of the 7 percent threshold more than two years before they originally forecast it would.

Half the economists in a Reuters poll on Wednesday said the BoE’s credibility has been hurt as a result.

Peter Dixon, economist at Commerzbank, says:

The problem is, and people sometimes forget this, that central banks have a much wider audience than just financial markets. The literature on central banks in the 70’s and 80’s said if you don’t tell markets what you plan to do, you tend to shock it into changing its behaviour. So, a policy that goes against popular consensus does give a central bank more bang for its buck.

That may be true, but markets weren’t having much of that argument on Wednesday. The Turkish lira was barely up on the day, losing most of about a 3 percent gain, while the South African rand fell to a new five-year low against the dollar.

(With contributions from Ross Finley in London and Rahul Karunakar in Bangalore)

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