Two More Lessons on Central Bankers’ Unpredictability

What happens when two central banks pause rate hikes, say some dovish things, then U-turn and hike rates? Evidently, what happens is people keep parsing their statements for clues as to what will happen next, as if they didn’t just see the fruitlessness of this endeavor firsthand. So it goes this week, with pundits trying to divine what the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) will do next after this week’s hikes. Dear readers, we suggest you not fall into the same trap—if central bankers can’t predict their own moves, how can mere mortals?

To see this, let us start with the RBA and simply take a tour of its recent policy decisions and statements. In February, as the bank hiked rates by 0.25 percentage point (ppt) or 25 basis points (bps), Governor Philip Lowe’s statement said the bank’s “Board expects that further increases in interest rates will be needed over the months ahead.”^[i] So no one was too surprised when the RBA hiked again in March—or that Lowe’s March statement said the “Board expects that further tightening of monetary policy will be needed to ensure that inflation returns to target and that this period of high inflation is only temporary.”^[ii] But then the RBA paused in April, surprising onlookers. That month’s statement referred several times to slowing economic growth, falling inflation forecasts and monetary policy’s tendency to hit the economy at a lag. The forward guidance—a fancy term for what central bankers say they expect to do—also got more dovish (or non-rate-hikey, if you aren’t into overused bird metaphors), saying more rate hikes “may well be needed.”^[iii] Not “will,” just “may well.” Many pundits figured this meant rate hikes were off the table for the time being.

Surprise! The RBA hiked by 0.25 ppt in May, defying expectations for more pausing. What changed? After assessing rate hikes’ impact, the Board decided it would take too long to get inflation back down to target if they didn’t resume hiking. Yet their guidance was still squishy, saying more rate hikes “may be required.”^[iv] Evidently that was indeed the case, as they hiked another 0.25 ppt Tuesday despite a raft of slowing economic indicators. And they have kept the “may be required” guidance, spurring another round of what will they do next?^[v]

We just don’t get it. “Will be needed” preceded hikes and a rate pause. “May well be needed” preceded a hike. “May be required” preceded a hike. None of it means anything, because—as every statement acknowledges—decisions depend on the evolution of economic and inflation data. These folks are reacting to changing economic indicators and forecasts based on their biases and viewpoints and how those influence policymakers’ expectations, which are always impossible to pin down exactly.

For lesson 2, see the BoC, which hiked Wednesday after pausing in March and April. When they had last hiked in late January, the Governing Council said that if the economy performed in line with their forecasts, they expect “to hold the policy rate at its current level while it assess the impact of the cumulative interest rate increases.”^[vi] But they also left the door open for more hikes “if needed to return inflation to the 2% target.” So March’s pause wasn’t a huge surprise. Neither was April’s, with both statements focusing on moderating inflation and weak GDP forecasts. Both statements also said the Governing Council “remains prepared to raise the policy rate further if needed to return inflation to the 2% target,” but with nothing like the clear-cut guidance in January’s statement, expectations for a move were low.^[vii]

So of course they hiked this week! And jolted Canadian bond markets in the process, sending interest rates up more than 15 bps across all maturities through 10 years.^[viii] The statement said the economy was running hotter than anticipated and conceded monetary policy to date “was not sufficiently restrictive to bring supply and demand into balance and return inflation sustainably to the 2% target.”^[ix] For those who don’t speak central banker, the translation is oopsie daisy. And perhaps aware that their past forward guidance wasn’t terribly useful, they didn’t even try to set expectations—instead, they just rattled off what they are watching for.

But that didn’t stop investors from trying to read the tea leaves. Futures markets quickly priced in another 0.25 ppt hike by September’s meeting.^[x] No doubt reporters will grill Deputy Governor Paul Beaudry about the BoC’s next move at the speech and press conference he is holding Thursday.

Some unsolicited advice to him: Don’t cave. Jettisoning forward guidance is a good thing. The less you commit to, the fewer U-turns you make, and the more credibility you store up. Central banks globally have defied their own guidance repeatedly since the concept became popular under former Fed head Ben Bernanke many years ago. The intent was to earn plaudits for transparency. Instead it earned mockery for the endless mind changing and, in one infamous exchange with politicians, the moniker “unreliable boyfriend” for former Bank of England chief Mark Carney.

If more central banks stopped trying to preview their next moves—and everyone stopped trying to guess what comes next—we would probably all be happier. Markets could go about their daily business of pricing in developments and data signals. Speeches would get far less attention, so we would get far fewer of them. Central banks could rebuild credibility. We could use automation and AI for things other than unnecessarily parsing central banker statements for small wording differences that don’t indicate anything about what they will do. All good things, except maybe that last one, which is pretty neutral.

But for now that seems to be a pipe dream, so let us all remember, always, that forward guidance isn’t reliably predictive, monetary policy isn’t predictable and interest rate decisions have no pre-set market impact. Central bankers do what they do when they do it, and it hits the economy at a significant lag, giving investors plenty of time to assess the merits and reposition, if necessary, after the fact.