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Central banks have had one consistent message over the past two weeks — “we are not close to cutting interest rates”. Financial markets were listening, of course, but they heard something different. They picked up the message, “we’re done with raising rates”.
This week I am going to look at three difficult aspects of communication arising from the recent policy meetings. I’d love to hear what you think central bankers should say to get their message across better. Email me at email@example.com.
Before you write that email, get your diaries out for the latest instalment of the FT’s (free to view) Global Boardroom virtual conference. Among many highlights, your central bank fixes will come from the European Central Bank’s Christine Lagarde on Friday November 10 at 12.30 GMT and the Bank of Japan’s Kazuo Ueda on Thursday November 9 at 08.35 GMT. I’ll be chatting with FT colleagues about UK prospects tomorrow at 10.00 GMT. Register here.
We’re not going to cut rates . . . (honestly we’re not)
Leaving the Bank of Japan to one side, central bankers had one message they sought to land at their most recent meetings. Tiff Macklem, Bank of Canada’s governor, started the ball rolling in late October, saying the central bank needed to “stay the course” with high interest rates. The top officials of the other central banks had their own ways of saying the same thing. At the ECB, Lagarde insisted that “even having a discussion on a cut is totally premature” before Jay Powell pronounced that, as far as the Federal Reserve was concerned, “the Committee is not thinking about rate cuts now at all”. Bringing up the rear at the Bank of England, Andrew Bailey chose, “it’s much too early to be thinking about rate cuts” as his phrase of choice.
In the US and eurozone, central bankers’ words did not appear to convince financial markets. The implied market probability of a US rate cut as soon as May 2024 rose from 29 per cent on Tuesday evening before Powell spoke to 41 per cent after his news conference a day later. In Europe, Lagarde’s words also appeared to raise expectations of a cut within six months, with the expected future interest rate next May falling 0.1 percentage points in the week after she said discussions were totally premature.
Now, of course, what I don’t know what these market interest rate expectations would have been if the central bankers had said that they had talked about cutting rates but had rejected the idea for now. What is clear, however, is that the “we won’t be cutting” words do not seem to carry much weight at the moment.
As I see it, the problem is that coming out so strongly against the possibility of rate cuts is frankly a bit odd from the same central bankers who have talked a lot about responding to the data and avoiding making commitments they subsequently feel obliged to fulfil.
It was Lagarde who told the FT over lunch last month that what she regretted most about her time at the ECB was having “felt bound by our forward guidance”, which prevented the bank from raising interest rates quickly. Similarly, Powell would have preferred not to have called inflation “transitory” in 2021 and retired the words because they made the Fed slow in responding to price rises.
Here is a pretty safe prediction you can hold me to and I am sure you will. If inflation comes down rapidly (as expected) in the months ahead and economic activity slows rapidly, the large central banks will soon face huge pressure to cut rates. “You were slow to raise, and you’re again asleep at the wheel,” people will say. Communication is not going to get any easier from here for central banks wedded to “higher for longer” if inflation falls fast.
This might happen sooner than you think. Look at the seasonally adjusted three-month annualised inflation rate for the eurozone below. The core measure is already down to 2.3 per cent.
The Fed statement on November 1 was almost identical to the previous one in September. The Federal Open Market Committee noted this month that the economy had been expanding at a “strong pace”, while in September, it had thought the pace of growth was only “solid”. This upgrade in the assessment of economic strength would normally be an indication from the Fed that it needed to do more to quell inflationary pressure because its interest rate rises had not slowed economic activity sufficiently.
But this month things were different. The statement on growth was balanced by adding the word “financial” to the following sentence from the September statement.
“Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring and inflation.”
The November FOMC statement read:
“Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring and inflation.”
Chair Powell explained in his news conference that tighter financial conditions “would need to be persistent” for the balance to work “and that remains to be seen”.
As so often, financial markets were not helpful and they promptly removed much of the tighter financial conditions in the aftermath of the Fed’s meeting. The 10-year US Treasury yield plummeted from more than 4.9 per cent before the Fed meeting to under 4.6 per cent at the end of the week, which made the Fed’s statement obsolete within a few hours of the central bank issuing it.
Luckily for the Fed, non-farm payrolls came in much weaker on Friday than expected too, undermining the “strong pace” description of the US economy and restoring the balance.
The episode shows how risky it is to communicate what was probably a “wait and see” interest rate decision by reference to one financial market price and some volatile economic data.
Weird forecasting decisions
Just as you probably are better off not knowing what goes on inside a sausage factory, it is often best not to look too closely at central bank forecasts, but I can’t resist bringing to you something really weird from the BoE.
There has been a massive 2 per cent upward revision in real UK GDP levels and this meant the BoE boffins in Threadneedle Street had to think again about the relationship between growth and inflation in the UK. It described its thinking in Box C of its latest monetary policy report.
Perfectly reasonably, officials decided that the upward revisions were in the past and inflation data stayed the same, so this meant that they judged the UK economy had been able to grow faster without stoking inflation. It said:
“The MPC has judged it appropriate to revise up potential supply in line with the revisions to measured GDP, such that the balance between them over the past is unchanged.”
So far, so normal. Then things took a strange turn. You might think that if the BoE had learnt that the UK economy was able to grow faster than it previously thought without generating more inflation, the same would apply today. But you and I would be wrong.
Instead, the BoE revised down its estimate of potential supply growth consistent with stable inflation for the year ahead. As far as the BoE is concerned, the trends in the past have inverse implications for the future, which is . . . an innovation in forecasting methodology.
This isn’t a mean reversion thing, just two bits of the forecast not talking to each other (the BoE promises to look at it properly in February). Let me know of other forecasting oddities you’ve spotted from the central banking world.
What I’ve been reading and watching
You must read Soumaya Keynes trying and failing to find anything good in published estimates of r* — the real interest rate that neither buoys nor depresses demand. But it’s OK, people, because Jean Boivin, head of the BlackRock Investment Institute, says the nominal equivalent (R*) is 5.5 per cent. Thanks Jean, that’s settled a long-running debate.
Martin Wolf attempts to answer the big question about how the war in the Middle East will affect the global economy. Most likely it will be “insignificant”, but if the conflict is not contained, it would be “far more serious”, he writes in what is about the best assessment possible at the moment.
Claudia Sahm, formerly of the Fed, very sensibly requests that people take the eponymous “Sahm rule” dating when the US is in recession seriously, but not literally in this series of posts on X, formerly Twitter.
If you are at all interested in the UK and the BoE and weren’t at the second BoE watchers’ conference last Friday, watch it.
A chart that matters
If you want beauty and huge uncrowded sandy beaches, go to Lithuania’s Curonian Spit. I was there in the summer. But the Baltic nation’s wonders do not extend to its banks. The latest ECB data for September shows the country to have the largest gap between lending rates and deposit rates. Given the national divergences shown in the chart, European banking competition and regulation are not working well.