CENTRAL BANKS ARE FIGHTING THEMSELVES, NOT MARKETS / THE WALL STREET JOURNAL

Central Banks Are Fighting Themselves, Not Markets

While it is good news that major Western central banks haven’t yet started raising rates, flip-flopping policy guidance should concern investors

By Jon Sindreu

The Bank of England held interest rates steady on Thursday./ PHOTO: TOM NICHOLSON/REUTERS

The relationship between central banks and financial markets is just like any other: You can’t learn to trust others if you don’t trust yourself.

On Thursday, the Bank of England left interest rates pegged at their all-time low of 0.1%. 

Even though U.K. consumer-price growth hit 3.1% in September, BOE Gov. Andrew Bailey said that “this period of higher inflation is likely to be temporary.” 

This echoed Wednesday’s statements by the Federal Reserve, which also struck a dovish tone despite dialing back bond purchases.

The BOE’s decision caught investors flat-footed. Derivatives called overnight index swaps were pricing in a certainty that U.K. borrowing costs would increase Thursday and would continue aggressively rising in the following months, pushing above 1.2% by 2023. 

Rate setters across emerging markets are already taking action, even as global growth decelerates. 

In Australia, the central bank bowed to pressure from the bond market Tuesday and abandoned its “yield curve control” policy.

Mr. Bailey was right when he said Thursday that “monetary policy can’t increase the supply of gas, it can’t increase the supply of chips, and of course it can’t increase the wind speed.” 

The best solution to inflation caused by bottlenecks is investing in production capacity. 

He also can’t be faulted for pointing out, like Fed Chairman Jerome Powell, that inflation can be high for quite a long time and still count as temporary.

It is good news, then, that the major Western central banks are now edging toward a wait-and-see approach. 

While the labor-market picture is encouraging compared with previous downturns, U.S. participation rates may still take time to recover to pre-Covid levels, and the impact of ending furlough programs in the U.K. remains uncertain. 

In its latest forecasts released Thursday, the BOE said the steep path of interest rates priced in by markets would eventually harm the British economy, with inflation dipping below the 2% target in 2024 due to weak demand.

So did markets get ahead of themselves with inflation fears, and even try to bully central bankers into raising rates prematurely—a pressure that the Fed and the BOE have heroically resisted? 

No, investors repriced their sterling OIS contracts at warp speed between the end of September and mid-October because officials told them to. 

Both Mr. Bailey and BOE rate-setter Michael Saunders expressed unambiguously hawkish views in public appearances.

In fact, the odd shape of the OIS curve, which priced in rates being cut after 2023, suggested that markets saw the BOE’s fast tightening as a mistake that would need to be reversed. 

In more recent statements, BOE officials suggested that they endorsed only the market’s view that rate rises may start soon, not the idea that they would keep going up so quickly after that.

Central-bank guidance matters because financial markets bring forward expected policy moves. 

U.K. financial conditions have already been tightened beyond the 0.15 percentage-point increase that the BOE was expected to deliver Thursday. 

Albeit far less strongly, the Fed has also been humming a more hawkish tune in recent months—causing a small hiccup in markets—and is now backtracking.

Investors can rest easy that rate-setters haven’t yet pulled the trigger prematurely. 

Unpredictable policy guidance, though, creates a risk that the next surprise will be a nastier one.