The tricky last yards of closing in on — and then maintaining — the hallowed 2% inflation target that all the major central banks adhere to requires a change of tactics. Over the past two years, a mantra of economic data-dependency has been drummed into us, keeping interest rates higher for longer. This ethos is in danger of becoming, well, a bit inconvenient as the mood swings toward rate cuts.
July US and UK consumer price inflation numbers this week are both expected to tick up. That risks muddling carefully crafted central bank messaging that restrictive monetary policy is coming to an end. The Federal Reserve is widely expected next month to follow the European Central Bank and Bank of England, which have already taken the first steps in lowering rates. But as Bloomberg's Chief UK Economist Dan Hanson pithily puts it: "The optics of easing policy when inflation is on the rise aren’t favorable."
A solution is available: Reduce reliance on monthly data and highlight how tricky forecasting is. This has the added advantage of reflecting common sense. After huge economic volatility since the pandemic, the unreliability of data has made divining economic outcomes ever harder. For instance, the travails of the UK's Office for National Statistics in collecting labor-force surveys is just the tip of the iceberg.
Rate-setters know that keeping monetary policy this restrictive for longer than two years magnifies the risks to a fragile economic outlook. They need a get-out clause if inflation data is bumping about while other signals such as unemployment or bank lending are flashing amber.
On cue, a speech entitled "Beware False Prophets" from Reserve Bank of Australia Deputy Governor Andrew Hauser warns about overconfidence in forecasting. Hauser's analysis puts some more meat on the bones of a July speech by BOE Chief Economist Huw Pill where he said "we have to be realistic about how much any one or two releases can add to our assessment." Hauser spent most of his career at the UK central bank, establishing a reputation as an innovative thinker. He is likely voicing the beliefs of many across the central bank world.
Perhaps it's no coincidence that the title of the annual Fed symposium at Jackson Hole, Wyoming, next week is "Reassessing the Effectiveness and Transmission of Monetary Policy." This comes as the Fed also subtly shifts from focusing mostly on inflation toward the unemployment aspect of its mandate.
BOE Governor Andrew Bailey didn’t even try to send the markets a signal at the Aug. 1 monetary policy review. “I’m not giving you any view on the path of rates to come — I’m saying we will go from meeting to meeting.” Bailey described this as a new framework “within which we are looking at policy which sits above the data.” This is a deliberate step-change to move the MPC's focus away from specific data releases to a new framework using "all the information available."
That's code for policymakers giving themselves more leeway and not being held hostage by volatile economic releases, notably the previously sacrosanct “three pillars” comprising services inflation, labor-market tightness and private-sector wage growth. The BOE’s rate cut, even though June services CPI was again substantially above its expectations, was significant. It showed the central bankers want market pricing to pay attention to what they are saying, not for participants to determine their own take on highly focused forecasts and outcomes. It also opens up the flexibility of making policy changes that could be presented as insurance if the economy started to struggle.
It's refreshing that central bankers are turning away from a myopic focus on lagging data and toward a flexible approach to exterminating inflation. We can all see the same statistics; it's their expert insight and judgment we pay central bankers for.
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