[Reuters Analysis] Five rules for ‘reading’ the Bank of England: Peacock

The views expressed here are those of the author, the former head of communications at the Bank of England.

By Mike Peacock

Feb 25 - The Bank of England’s recent interest rate cut and accompanying economic forecasts have prompted a flurry of conflicting views about where monetary policy is heading, raising the question of how BoE-watchers should "read" the committee’s actions in these uncertain times.

All nine members of the Monetary Policy Committee voted to cut rates in February, with two calling for a larger reduction than the quarter-point that resulted. The Bank downgraded its economic growth forecast for this year but said it expected inflation to peak higher than previously expected, at 3.7%, well above the 2.0% target.

Analysts drew a variety of conclusions from this meeting, with some predicting four or more rate cuts and others expecting two or fewer. These contrasting paths would have profound – and very different – implications for the UK growth outlook, the basis for much of the Labour government’s agenda.

So how should one properly "read" the actions of Britain’s MPC? Here are my five key rules to keep in mind.

1. The MPC vote can send a strong signal about future policy decisions, but not always.

This month, some pundits seized on the fact that two MPC members voted for a larger cut to argue that the BoE was going to turn more dovish. But it is far from clear whether the other members are inclined to accelerate the pace of easing. And there is certainly no evidence that any MPC has ever engineered a split vote at one meeting to send a signal about future policy moves.

Central bankers start each meeting with a blank slate, and the MPC’s structure – five senior Bank staff and four external members – is designed to provide a breadth of views. So even a 5-4 split at one meeting might not indicate an imminent policy shift if the five fundamentally disagree with the four and are unlikely to budge.

2. MPC members are rarely immovable "hawks" or "doves".

Some analysts were surprised that external MPC member Catherine Mann called for a half-point reduction at the most recent meeting. Mann, who has been labelled an "arch hawk", voted against both of last year’s rate cuts.

But Mann is simply doing what members are supposed to do, responding to changing data with what she deems the proper policy response. She told parliament’s Treasury Committee last year, "When I do cut, it will be more aggressive", arguing that a large move would send a stronger signal and get a more immediate economic response. However, she has also noted that her recent vote does not mean she is now going to "cut, cut, cut".

3. Policy forecasters should focus on the MPC’s reaction function.

This means identifying which economic areas the committee is watching most closely. Currently, wage growth is a key factor, and one that has been obscured by deficiencies in official UK labour statistics, which the Bank has flagged repeatedly.

Since a global energy shock in 2022 prompted inflation to spike, one of the Bank’s main concerns has been that demands for higher wages to meet the rising cost of living could create a vicious cycle, leading to a more persistent round of inflation.

The BoE’s own survey of businesses suggests average pay rises will hit 3.7% this year, something BoE Chief Economist Huw Pill recently highlighted.

4. Understand the assumptions underlying the forecast.

BoE economists use various assumptions in their forecasts, most notably, the implied market path for future interest rate moves. This time around, they plugged in a "market curve", which put interest rates at 4.0% in 2027, compared to 4.5% today.

This, in turn, fed into their overall forecast putting inflation at 1.9% in three years, only a fraction below target. If this does play out, expectations for only two further quarter-point rate cuts do not seem wildly out of line.

5. Changes in language can be important, particularly when MPC members emphasise them.

This month, the MPC labelled its approach "gradual and careful", as opposed to simply "gradual", the descriptor used at previous recent policy meetings. Governor Andrew Bailey told a press conference: "There is more uncertainty. That's why we've paired gradual and careful."

Central bank communications are often criticised for being unclear, but the intention of central bankers today is to be as transparent as possible. They have come a long way since former Federal Reserve Chairman Alan Greenspan told a panel of U.S. lawmakers: "If I seem unduly clear to you, you must have misunderstood what I said."

In a world of heightened uncertainty, however, providing clarity is challenging because it entails explaining what policymakers cannot be sure about.

Uncertainty fosters caution. So, now more than ever, the ultimate key for BoE-watchers is to channel economist John Maynard Keynes and see if the facts change.

(The views expressed here are those of Mike Peacock, the former head of communications at the Bank of England and a former senior editor at Reuters).