THE BLOG
04/07/2013 18:31 BST | Updated 03/09/2013 06:12 BST

Carney and Draghi Make Their Mark

In dramatic breaks with history, Mark Carney and Mario Draghi persuaded the Bank of England Monetary Policy Committee (BOE) and the European Central Bank Governing Council (ECB), respectively, to issue what amounted to forward guidance on the path of future monetary policy, without having to actually formally announce they had done so.

In the case of the BOE, the key sentence was, 'The, (recently observed), significant upward movement in market interest rates, would, however, weigh on that outlook; in the Committee's view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy' and in the case of the ECB, 'The Governing Council expects the key ECB rates to remain at present or lower levels for an extended period of time.'

Since, (in contrast to Carney), Draghi also had the opportunity to expand on the statement at his subsequent news conference, he then drove home the message by telling us that the decision was unanimous and also that the phrase, 'key ECB rates' included the deposit rate, (currently zero), and that the 'zero-bound was not 50bp away'- presumably referring to the current level of the Refinance Rate; 0.50%. Generally, he adopted a tone that could be characterized as one of virtually undiluted concern about economic downsides, verging on pessimism.

What a relief that we no longer have to employ advanced lexicology to decipher the hidden meaning of the utterances of M. Draghi's predecessor, Jean-Claude Trichet, who was firmly of the style of central banker-speak made famous by Alan Greenspan, who was once heard to suggest that, 'If I seem unduly clear to you, you must have misunderstood what I said'!

Trichet used code words and phrases; one just had to understand what they meant-

Appropriate - rates are not about to change, so even its omission could be significant.

Monitoring - often qualified with the words 'closely' or 'very closely'; watch out-change may be coming

Heightened alertness - change is a tad more imminent

Strong vigilance - the nuclear option-rates will change at the next meeting

Pretty ridiculous in retrospect, really.

There are arguments against, and arguments in favour of forward guidance:

Against - the guidance ties the committee's hands and will make it look stupid if it subsequently has to adapt it too quickly, (almost by definition), and if it does have to change the message that's going to surprise the market, leading to confusion and volatility and ever-diminishing credibility for future guidance, i.e. the market will remember the committee's 'mistakes' and not believe future guidance.

For - it represents 'costless' intervention, in the narrow sense that the central bank doesn't have to actually DO anything right now and, if the guidance does have to change direction later, then that will probably be because the initial guidance has done its work-having lead to the desired economic adjustment.

The substance of today's messages from both central banks was that they had seen their yield curves steepen dramatically since the market became obsessed with 'tapering' in the US - the process by which the Fed may wind down its programme of Quantitative Easing - and that they could neither understand this phenomenon nor stand idly by and watch it happen. To paraphrase their message, "never mind the US, or the Fed, look at our economies and ask yourself, why would you expect us to raise rates any sooner now than you did two months ago". Fair enough and, in Draghi's case, a very good point.

However, I think Carney has started his encumbency with a very risky gamble. Whilst the Eurozone economy has been flatlining and boasts economies ranging from zombie to plunging, the UK economic data has recently given us some distinctly pleasant surprises-the latest being the Services Purchasing Managers' Index, representing a massive sector of the economy. Let us also not forget that UK inflation remains stubbornly high and shows no real tendency to fall. Maybe not today, maybe not tomorrow, but probably by Christmas, I think the BOE will have to subtly change today's attempt at guidance and investors who bought gilts on the back of today's BOE statement may come to regret that before long.

Perhaps ironically on US Independence Day, the message that both men were trying to convey was that they set rates and not Bernanke. I would say, conversely, don't expect the latter to use his next big speech, on July 10th, to back-track on his message that US monetary policy is about to become less accommodative-he had his chances to mollify the message over the last few weeks and notably failed to do so.

Get used to this new world of 'universal' guidance, but take it with a pinch of salt, it may seem less opaque than the Greenspan era, but the messages can still be 'wrong' if that's what subsequent economic outcomes dictate-buy bunds by all means, and even Portuguese bonds if you're more adventurous-the latest hoohaa will probably blow over and, if it doesn't, your bunds will sure look good, but not Gilts or Treasuries.