Seven lessons from three central bank meetings

The Bank of Japan moved first last week, raising its main interest rate from about 0.1 per cent to 0.25 per cent early on Wednesday morning, with hawkish language about the future and a new focus on the yen.

The Fed surprised very few people by holding its main rate at 5.25 to 5.5 per cent later on Wednesday, but signalled a cut in September. The next day, the Bank of England voted 5 to 4 to cut rates by a quarter point to 5 per cent.

Three different policies, but I noticed seven themes.

1. Some meetings are more important than others

With hindsight, the BoJ’s meeting was pivotal, while the Fed and BoE meetings were merely interesting. In Tokyo, the hawkish move to raise rates, the focus on the yen and the guidance that more rate rises were coming this year surprised almost everyone.

The market reaction and the lightning quick unwinding of carry trades will have surprised the BoJ. None of it looks very clever six days on. For sure, Japanese wages grew strongly in June, bolstering the BoJ’s case, but when you pull on a piece of elastic tied to a brick, at some point it will smash you in the face. I am sure the BoJ did not intend to generate the reaction it caused, even if some of the market movements were clearly excessive.

In contrast the Fed and BoE meeting outcomes were either exactly as expected or close to expectations and cannot easily be blamed for the subsequent market turmoil. Even though the FT was able to find lots of people to be beastly about the Fed on the record on Friday, they were quite quiet until the markets puked.

2. A shift towards forecasts from data

In a timely response to last week’s newsletter, central bankers are putting more emphasis on their forecasts again and less on individual pieces of data.

The Bank of Japan justified its rate rise saying that, “economic activity and prices have been developing generally in line with the outlook presented in the previous Outlook for Economic Activity and Prices”.

At the BoE, there was a similar shift among the five members voting for a cut. Clare Lombardelli, the new deputy governor for monetary policy, spoke for the majority when she said the UK economy “is evolving broadly in line with [the BoE’s] expectation, and that gives you more confidence that you’re in this world where inflationary pressures are reducing”.

Jay Powell, Fed chair, struck a slightly different tone, still sticking to the line that he wanted to see more data to add to the comfort that inflation was falling, but again officials in Washington think the economy is evolving in a way that meets its dual mandate of stable inflation and maximum employment. Obviously, this came ahead of Friday’s poor jobs data and the September rate cut is even more nailed in place now.

3. Casting the data net more broadly

A big shift across all central banks has been to look at what Powell called “the totality of the data”. He also copied ECB president Christine Lagarde’s phrase, saying the Fed would be “data dependent, but not data point dependent”. The BoE ditched its previous focus on the labour market, wage increases and services prices, replacing these with a focus on “a broad range of indicators”.

The BoJ had been a bit sniffy about talking exchange rates, but noted last week that import prices were rising again and this warranted “attention”. There is no doubt that the hawkish language deployed by the BoJ has helped turn around what seemed to be a persistent slide in the yen. The problem is that it got more than it bargained for.

4. Interest rate turning points are manageable

There was a fear in central banks that the first move in interest rates would have an outsized effect on markets. This was initially dispelled by the European Central Bank’s well-flagged cut in June, which was met with little action.

You might think that the extreme volatility proves me wrong. But the chart below shows there was less movement last week in sterling forward interest rates than in those from the US. For sure, it showed quite a large movement, but this was more a widespread reaction to the US than anything UK specific. Well explained rate moves do not necessarily cause market to expect a huge reversal.

5. Politics and central banking is entwined and messy

There were certainly suspicions that the Japanese government lent on the BoJ to raise rates early in a bid to defend the yen last week. That went well. Elsewhere, things were no easier.

BoE officials had to talk about how the new government’s revelation of a large public sector overspend would affect policy. The answer from the BoE was that it did not enter into their thinking in last week’s meeting and they would think again in their next forecasts. I can remember only two times — shortly after the 2010 election and in the wake of Liz Truss’s disastrous “mini” Budget in 2022 — when the BoE has actually said that fiscal policy was affecting its thinking. Normally, it finds an excuse to dismiss the idea, messy as this is.

Jay Powell also swerved the US election issue deftly, saying it was having no effect on deliberations for a September rate cut and the Fed was not forecasting any change in economic policy. What that means in practice is that it is forecasting on the basis of a Harris victory, though it cannot say that.

6. Scenarios have a long way to go before they are useful

A Trump victory would be a good scenario to test. The Fed could be public about what it would do in the circumstances, revealing its reaction function to outsiders. But Powell was not going anywhere near that hot potato last week. Asked if the Fed’s models looked at the economic policies of different candidates, chair Powell was unequivocal:

“No. We do not do that. We absolutely do not do that. We don’t know who’s going to win, we don’t know what they’re going to do, we don’t act as though we know and we just can’t do that.”

Andrew Bailey was keen to talk about scenarios and said that the minority view on its Monetary Policy Committee, suggesting structural impediments to a fall in inflation, was, “a prototype economic scenario of the kind that Ben Bernanke has recommended”. He asked us to look at the mean forecast of inflation compared with the mode (below).

If that is what the BoE is wanting to produce, it will fail. The two lines are little different with inflation falling below target in both. Essentially the scenario was akin to saying, “the economy might do this or it might do that” and it makes little difference. It does not need me to say that this is not very informative or useful.

7. Central bankers are struggling with guidance

Powell repeatedly had to check himself to say that the Fed really had not decided to cut rates in September, giving the impression that it had in essence made up its mind. The best moment was when he denied a September rate cut would be political before saying that “we haven’t made any decisions”.

I asked Bailey to define the statement that the Bank of England would not cut rates “too much or too quickly”. He refused. Without a definition, the phrase is clearly empty, but we understand the vibes the BoE was trying to impart. Subsequently I did get a better explanation that the phrase is intended to convey the idea that the BoE is not currently minded to cut at the next meeting in September. You might think it would be easier just to say it.

The BoJ’s hawkish guidance was, by contrast, clear. And financial markets hated it. This central banking business is difficult.

What I’ve been reading and watching

If you want a round-up of all that is concerning in the US economy, Tej Parikh was feeling gloomy last week. Alternatively, read Unhedged telling everyone (correctly) to calm down

Chris Cook was a little more optimistic about the effects of sanctions on Russia. This is a must read for what is working and what is not

Leo Lewis started last week noting that the yen is everything. This week he augments this with a column noting the speed and ferocity of Japan’s market correction that is reinforcing the view that global investors find it very easy to sell Japan

A fascinating experiment in central bank digital currencies and basic incomes is under way in Thailand. Eswar Prasad here outlines what is at stake and the inevitable ways people will subvert the government’s attempts at social engineering. This digital temporary money is worth less than a proper baht and almost certainly will trade below it on the secondary market

A chart that matters

OK, the Sahm rule was triggered in Friday’s US jobs report. It states that if the three-month rate of unemployment is 0.5 percentage points or more above the rate in the previous 12 months, the US economy is already in recession. The figure in the July data was 0.53 percentage points.

This has been a very good indicator in the past, but probably not this time. As former Fed official Claudia Sahm, after whom the rule was named, herself said, the rule at the moment is “sending the right cautionary message about the labour market, but the volume is too loud”. Its importance has been exaggerated.