The Monetary Policy Committee has been with us for the best part of 10 years and has held more than 100 meetings. It's not been short of words either. That's long enough, you might think, for us to have got to know it rather well; long enough even, as Mervyn King once suggested, for us to have got bored by it. In the event, we still care. The fact is that, despite its best efforts and our own, we still can't be certain what it will do. The meeting that ends today is a good example. There are analysts who think rates are likely to rise today, others who think they probably won't today but probably will before long, and some who think that rates won't rise anytime soon.
For what it's worth, we are in the second group. In Credit Suisse's view, rates are likely to rise before long - for all the usual reasons - and the real uncertainty is not so much whether it happens but when it happens. To that extent, it's all about timing. It makes sense to look back at what the committee has done in the past for clues as to what might happen now. It's 12 months since rates were last changed. The cut this time last year came at the committee's 100th meeting. It changed rates just over 30 times in those meetings. However, roughly two-thirds of those changes took place in the committee's first 50 meetings and only one-third in its second 50 meetings.
There were other differences between the two periods, so we should be careful not to over-interpret the results, but they do suggest that the committee may have become less active in the more recent period. It's also the case that rate changes have taken place in months in which there has been an Inflation Report to a greater extent in the more recent period. That was not the case initially, but it seems to have become so now. The result of both points taken together is that there have been only six rate changes in the past three years - an average of just two per year - and five of them have taken place in a month in which there has been an Inflation Report.
So why has the committee become less active? In the early days, the idea seems to have been that if the numbers or the forecast changed, so should rates. Rate changes were a good thing. It didn't matter that much if they subsequently turned out to be inappropriate because they could be reversed. More recently, this approach has given way to one that puts more weight on continuity and communication. The traditional argument for continuity is that if there is uncertainty about the effects of policy changes, a large number of small moves is probably better than a small number of large ones. That may have been relevant as rates came off the low levels of a few years ago.
It doesn't explain, however, why the committee has continued to be so cautious now that rates are back at more normal or neutral levels. A newer argument for continuity and communication is that the effectiveness of policy depends on where rates are expected to be in future as well as where they are now. The economy is unlikely to respond to a rate rise today if it thinks there might be a cut tomorrow. It's better to make rate changes that persist and, as far as possible, avoid policy reversals. The result is that there are fewer policy changes and that those that are made last longer. On this view, turning points in policy are particularly important.
It's also that there is more communication. There are times when a well-judged word or two can take the place of a policy change if it has a similar effect on expectations. The same Mervyn King who said we should all be bored by now called this the Maradona theory of rates. He suggests that the reason Maradona was able to run in a straight line through the opposition to score the second of his two goals against England in the World Cup all those years ago was because they expected him to do something different. It is the same with monetary policy. Sometimes policy rates don't need to change as much as might otherwise be the case because expectations that they could change are sufficient.
How is all this relevant to the committee's current decision? The first point is that rate expectations have clearly changed over the past year. Market rates have gone from pricing in lower policy rates to pricing in higher policy rates. They have changed by a reasonable amount, though policy rates haven't changed at all. It's also the case that the committee has encouraged that shift to some extent. The forecasts in the last Inflation Report, for example, showed inflation hitting the target on the basis of market rates and not doing so on the basis of unchanged rates. It's clearly relevant that the recent growth and inflation numbers have largely been in line with that forecast.
It's unlikely, then, that the new forecast, to be released later this month in the next Inflation Report, will look very different from the last. If anything, the inflation forecast might be a little higher now than it was then. The committee could say it has given fair warning that rates were likely to rise and that it's time for them actually to do so. It could also point out that it won't be a complete surprise if it does.
On the other hand, it hasn't given a clear sign - in the last minutes or in recent speeches - that any rise is imminent, so it would still be something of a surprise if it took place today. In effect, the committee is caught between the various precedents that it has established.
The best way to resolve the dilemma, in our view, would be to leave rates unchanged again today and to make it clear, in the inflation report and in the minutes of the current meeting, that a rise really is imminent. A forecast that rates need to rise doesn't necessarily mean that they need to do so that month. It's possible that rates will rise today, but it would be better if they did so next month or the month after that.
Either way, and more generally, it's probably time for the committee to get out of the habit of only changing rates in Inflation Report months and to consider doing so in others as well.
The author is head of European economics at Credit SuisseReuse content