Like the Fed, Bank of England could go 'dotty' with forward guidance

LONDON Mon Feb 3, 2014 10:59am EST

The logo is seen at the Bank of England in the City of London January 16, 2014. REUTERS/Luke MacGregor

The logo is seen at the Bank of England in the City of London January 16, 2014.

Credit: Reuters/Luke MacGregor

LONDON (Reuters) - When it begins overhauling its "forward guidance" policy this month, the Bank of England may be tempted to look across the Atlantic for inspiration, perhaps even cloning one of the tools that has served the U.S. Federal Reserve well.

It could all be in the "dots" - a published matrix of where rate-setters think interest rates are heading. That, at least, is one of the things the Bank is expected to ponder.

Central banks, unable to cut rates much below their record low levels, have resorted to forward guidance, or statements of intent, to persuade markets and the public they will not raise rates for a long time as economies struggle back to growth.

The BoE introduced its guidance only six months ago, but it hasn't worked out as planned.

Britain's unemployment rate has fallen within a whisker of the 7.0 percent level at which the Bank had said it will review interest rates. That is far sooner than expected, forcing policymakers to stress they have no plans to hike rates soon.

So Governor Mark Carney has said the Bank will start looking at how to "evolve" - or in other words, overhaul - guidance this month, generally taken to mean when it unveils the quarterly Inflation Report a week on Wednesday.

Although the BoE might not set out in detail how it will expand forward guidance, the report might at the least offer insight to its thinking.

While many economists expect it will eventually broaden guidance to include more economic indicators such as wage growth, it could make a bigger impact with evolving Fed-style "dot" charts.

The Fed introduced a "dot chart" in its January 2012 economic projections. Each dot represents the view of an individual policymaker on how they see the appropriate level of interest rates for the coming few years.

Those charts seem to have served policymakers on the Fed's Open Market Committee (FOMC) well.

"The market fully believes what the FOMC has said - that's a great success for the Fed," said Roberto Perli, a former Fed official involved in drafting policy and statements, and now partner at economic research firm Cornerstone Macro.

While the Fed's guidance also centers on an unemployment rate threshold, it can also rely on these charts to bolster its low-for-long message on rates - even as the jobless rate falls towards its own 6.5 percent staging post.

"The market currently is exactly on path with those charts, so it's hard to argue they've not been so far successful. They act as a guidepost," said Perli.

By contrast, BoE policymakers have struggled to convince markets that an interest rate hike is unlikely in 2014.

Goldman Sachs economists Kevin Daly and Sebastian Graves also raised the prospect of the BoE adopting the Fed's dot charts, in a note to clients on Monday.

"We see some attraction in the introduction of Fed-style 'dots', the most notable being that it would reflect the plurality of views that exists within the committee," they said.

"Such an approach would also have the advantage of being able to counter the perception that interest rates are likely to rise soon after the recovery gets underway."

However, they said introducing them might not be straightforward, given some policymakers have been reluctant to forecast interest rates in the past.

EARLY DAYS

Forward guidance is also a relatively new tool, not tested over a period of years, even if the Fed has been having some success. So that might act as a brake.

"There's no experience of whether or not those projections are in line with what the Fed actually does in terms of rate hikes eventually. We don't know. For now they're just telling us what they are thinking," said Perli.

Around half the economists surveyed in two separate Reuters polls have been critical of the BoE's forward guidance, many arguing it has been too complex.

As well as the unemployment rate threshold, the guidance is subject to three caveats based on inflation and financial stability. Its last inflation report contained different sets of forecasts based on market expectations and constant rates.

When the BoE does overhaul forward guidance, it may do well to simplify it.

That point was underlined in December by Bank of Japan Governor Haruhiko Kuroda, who said that central banks offering complicated messages to markets may have unintended consequences.

"Too complicated forward guidance, or too complicated communication, could be less efficient and sometimes even disruptive," he said.

(Editing by Jeremy Gaunt)

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