Deft footwork by the hawks, and the subtleties of forward guidance when the causes of yield movements are unknown

Following the publication of the minutes of the MPC meeting on 3rd/4th July, I think a tweak is necessary to my reading of the press statement accompanying the decision. The minutes suggest the possibility that the tightening in the short end of the yield curve did not accurately reflect market expectations (eg were unrelated to movements in surveys of economists’ interest rate expectations).  If indeed that tightening was caused by an increase in some other premia, the previous path for interest rates preferred by MPC would no longer be adequate, since the rise in yields caused by the change in premia would be expected to feed through into the rates paid by borrowers, and depress spending and therefore inflation.  Hence, it would be necessary for the central bank rate to remain lower for longer.  Not lower for longer than would historically have been guessed by markets given what they understand about central bank concerns, (therefore not strictly warranting a Fed or BoC style forward guidance commitment) but lower for longer than would have been the case had there not been a rise in this unnamed premia.

Because of the difficulty of getting an accurate read on interest rate expectations, the task of deciding on and then communicating about future interest rates is especially delicate.  If interest rate expectations in markets are misalligned because of some difference in view about the conjuncture or what the MPC is trying to achieve, it’s possible that allignment will be achieved by talking clearly about future rates.  Though it’s possible that it won’t, and, in that eventuality, lower rates than otherwise would be warranted, a scenario that MPC could communicate about.  If there is no misallignment, but simply a change in the premia driving a wedge between prices and expectations, then lower rates will be warranted, and presumably expected.  But there is also a hybrid possibility of course; there may be a difference in view about this premia between MPC and markets.  The reality is that MPC presumably have to weigh up all three possibilities, and explain that that is what they are doing! [and what they would do if they were misconstrued, etc etc]

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