Analysis: Forward guidance more than passing fashion for central banks

Thu Jul 11, 2013 7:08am EDT
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By Sakari Suoninen

FRANKFURT (Reuters) - "Watch what we do, not what we say," was the central bank mantra for generations. But no more.

In the space of a few hours last week, the European Central Bank and Bank of England embarked on a momentous change, moving to provide an interest rate outlook as the Federal Reserve already does, a crisis response that could become a permanent feature.

Market turbulence after the Fed floated an exit plan from its money creation program forced them to give "forward guidance" on rates for the first time to try and temper rising bond borrowing costs.

While the Bank of England will spell out its plan in detail next month, it said markets were over-aggressive in pricing in rate rises. The ECB contented itself with saying rates would stay at record lows for an "extended period" and could fall further.

ECB chief Mario Draghi called the move "unprecedented", showing that ditching the tradition of not pre-committing proved hard. Previously the ECB used code words such as "strong vigilance" to hint at rate moves a month or at most two in advance.

"No pre-commitment was the bible for the ECB for many, many years," Graduate Institute of Geneva Professor Charles Wyplosz said. "The new management of the ECB has already rewritten the bible in many ways, in good ways."

Central bank guidance has come a long way.

Looking back a generation, some did not even publish their interest rate decisions, but let markets figure them out. This included the Fed, which started publishing them only in 1994.   Continued...

The headquarters of the European Central Bank (ECB) are pictured in Frankfurt June 6, 2013. REUTERS/Ralph Orlowski