ECB FOCUS – Muddying the message on forward guidance

July 12, 2013

FRANKFURT, July 12 (Reuters) – In just a week, European Central Bank policymakers have blurred their forward guidance on interest rates with a cacophony of comment that risks undermining the ploy.

Abandoning its tradition of never pre-committing on future rate moves, the ECB said last Thursday it would keep its interest rates at present or lower levels for an “extended period” – its first use of forward guidance.

ECB President Mario Draghi, who delivered the message at his monthly news conference after a meeting of the 23-man Governing Council, described the move as “unprecedented”.

Beginning the next day, Council members began offering their own, varied interpretations on exactly what the guidance means and just how big a deal their use of the ploy really is.

First Erkki Liikanen said the move was good for as long as the economy is weak, then Joerg Asmussen said the extended period “is not six months, it’s not 12, it goes beyond”, though he was quickly hauled in by ECB headquarters.

Later, Jens Weidmann insisted the ECB had not “tied itself to the mast” with the guidance, and would raise rates if inflation climbs.┬áThen Benoit Coeure, generally seen as a policy dove, said the guidance would be reviewed each and every month.

The result is that while the forward guidance initially helped persuade markets that the ECB is not about to follow the U.S. Federal Reserve and begin exiting its ultra-loose policy stance, the ECB risks talking away this ‘decoupling’ effect.

“The ECB’s message is getting muddied by what seems to be its own internal misconception of what its forward guidance means,” Lena Komileva at G+ Economics wrote in a research note.

The impact of the policy statement is already fading.

Shorter-dated euro zone sovereign bond yields fell after Draghi’s declaration but have since rebounded, and forward rates on three-month Euribor interbank lending rates initially fell before edging up again. Forward euro zone overnight Eonia rates have also started firming again.

The experience of other central banks shows such guidance is by nature difficult to manage. This is all the more the case when dealing with 23 policymakers from different countries, with different native languages.


Across the Atlantic, Federal Reserve members are at odds.

About half of the Fed’s policymakers felt the U.S. central bank’s bond-buying stimulus should be brought to a halt by year- end when they met in June but many wanted reassurance the U.S. jobs recovery was on solid ground before any policy retreat.

Unlike the Fed and the Bank of England, the ECB does not publish minutes of its meetings, which can make its policy communication more opaque.

Furthermore, ECB policymakers often tailor their comments to their own constituencies. Weidmann, for example, has to assure a wary German public that the ECB is not playing fast and loose with inflation.

The ECB guidance is also less specific than the Fed’s.

Aside from calling time on its quantitative easing programme, the Fed has promised to keep its main interest rate near zero at least until the unemployment rate falls to 6.5 percent and as long as inflation stays below 2.5 percent.

With the ECB guidance subject to monthly reviews, it really amounts to a formal recognition of what markets expected anyway. A Reuters poll conducted before last week’s meeting showed analysts saw rates on hold until at least the end of next year.

Sassan Ghahramani, CEO of U.S.-based SGH Macro Advisors, which advises hedge funds, said guidance is powerful when it reinforces what markets already suspect or would like to see, as with Draghi’s commitment to low rates for an extended period.

“But it has a limited shelf life and usefulness if it is left without an explicit anchor and open to constant interpretation of what data developments may pull the central bank off of the promise,” he said.

For more impact, the ECB may yet need to back up its vow to keep rates low with more specific guidance, or other measures.

Draghi said on Monday it remained to be seen whether the ECB’s use of guidnace would be sufficient.

“For the ECB to get greater bang for its buck, it will either need to link its commitment more explicitly to its inflation target and in the process deliberately give up some flexibility,” said Ghahramani.

“Perhaps easier for them and less controversial, put some ‘money behind their promise’ by offering a new, low fixed rate LTRO to banks even if they are not clamouring for the money.”

Although ECB policymakers are sending mixed messages over guidance, they agree that rates should remain low in the absence of inflationary pressures.

The next ECB staff forecasts are due in September. In past years, the staff have not been afraid to project inflation above the ECB’s target of just below 2 percent but in June they saw it at just 1.3 percent next year.

“Behind the divergence (in Governing Council views) are different expectations of how quickly the economy will recover,” said Christian Schulz at Berenberg bank, a former ECB economist. “The key message is that the ECB does not want to raise rates prematurely.”

Back to list