Whatever Mario Draghi says about the European Central Bank’s bond-buying programme this week, he’s not likely to provide much more clarity about his plans for interest rates.
The ECB president and his colleagues will discuss, and may announce, an end to asset purchases when they meet on Thursday. But they’ve so far brushed off questions on how they might change their guidance that borrowing costs will stay at current record lows until “well past” the end of net buying.
Instead, policy makers have repeatedly said investor expectations for a rate hike around the middle of next year are currently reasonable. Such verbal steering of the market outlook may prove to be the preferred option as the exit from monetary stimulus gets properly under way, suggesting they’ve gleaned from peers at the Federal Reserve and Bank of England that being too specific can backfire.
“It’s not as though the central banks that have gone down that road have covered themselves in glory,” said Richard Barwell, an economist at BNP Paribas Asset Management in London. “The lesson learned here is that if you’re not courageous enough to publish a path for interest rates then you’re better off saying very little and avoiding confusing the market with arbitrary signposts.”
Economists surveyed by Bloomberg predict the ECB will raise its deposit rate in the second quarter of 2019 and the main refinancing rate in the third quarter. Bundesbank President Jens Weidmann and Bank of France Governor Francois Villeroy de Galhau have recently said that’s realistic.
For now, there’s no reason to be more specific. Asset purchases will run until at least September and probably won’t be phased out completely until the end of the year. Inflation is only gradually picking up, and the extent of a slowdown in the economy this year is so far unclear. A report on Tuesday showed German investor confidence at its lowest level since 2012 after Italy’s political strife sparked a bond slump and a global trade conflict intensified.
Central banks have latched onto so-called forward guidance in recent years, trying to reduce uncertainty and avert market volatility by deliberately signaling when they might tighten monetary policy. It’s an experiment that has undergone some rapid changes.
In December 2008, the Fed gave an indication that rates would stay low “for some time.” It added a more specific date in 2011, twice extended the time frame, switched to linking its plans to the unemployment rate, then pledged that asset purchases would end before rates would rise.
Borrowing costs were finally increased in December 2015, after a series of heavy hints that a move was in the offing, without shocking investors.
BoE Governor Mark Carney brought in guidance when he started in 2013, saying a drop in unemployment to 7 percent would be the trigger to consider raising rates. The U.K. blew past that level within six months without much sign of faster inflation and the next move turned out to be a rate cut in 2016, in the wake of the country’s vote for Brexit.
More recently, BoE officials debated and ultimately rejected publishing an explicit forecast for the path of interest rates, similar to the strategy of Sweden’s Riksbank and Norway’s Norges Bank. The Fed publishes an indication of where policy makers think interest rates are headed, known as the dot plot.
ECB policy makers have shown no sign of wanting to tie their hands on rates to a specific date. Linking to an economic indicator other than inflation is even less of an option given that the institution’s primary mandate is price stability - unlike the Fed, which has to balance inflation and employment.
That leaves guidance coupled with occasional commentary on market expectations as the most likely way forward. It’s not a guarantee of success, as the BoE found out in the spring when Carney played down the prospect of a May rate hike that the bank had previously signaled was likely. That sent the pound tumbling.
If such incidents have taught investors to pay closer attention to incoming data instead of relying on the comments of central bankers, the ECB can be a beneficiary. It also has the luxury of a global economic backdrop that is more robust than when the Fed and BoE were doing the groundwork for exiting crisis-era policies. In short, investors might be more willing to give the ECB some room for flexibility.
“We should expect some modest language changes at some point, if only because QE is coming to an end,” said Andrew Cates, senior economist at Nomura International Plc in London. “But I don’t think they’re going to be that much less vague than they are at present.”