In today’s complex financial landscape, central banks play a large part in controlling price stability and inflation. They do so by managing the currency and monetary policy of a country or union.
Central banks have featured heavily in the media in recent years. They attracted heavy attention for deploying monetary policies such as quantitative easing during the Covid-19 pandemic, or in the last 12 months as the world grappled with high inflation levels.
But it could be hard to distil relevant information or make sense of decisions central banks make. In this blog post, we will explain what central bank signalling is and explore its benefits and pitfalls.
Who are the main central banks and what do they do?
There are many central banks across the globe, but the main central banks that you may be familiar with are the U.S Federal Reserve (Fed), the Bank of England (BoE), and the European Central Bank (ECB).
The role of a central bank in its simplest form is to ensure the stability of a country’s, or an economic region’s, financial system. One of its key objectives is to maintain inflation at or around a target level; for example, the BoE’s long-term inflation target is 2%.
Central banks possess a variety of monetary policies, such as quantitative easing (QE) and quantitative tightening (QT), to help them control pricing and interest rates. QE involves the purchase of bonds to increase prices and decrease long-term interest rates, and QT means the opposite – it restricts the amount of money in general circulation by selling bonds.
During periods of high inflation, central banks raise interest rates to restrict the supply of money and therefore bring inflation down by limiting people’s and business’s ability to spend or invest. These decisions are taken by specific committees within the central bank. At the BoE this is the Monetary Policy Committee, at the Fed it is the Federal Open Market Committee and at the ECB it is the Governing Council.
Why are interest rate movements important?
Changes in interest rates are important to everyone – not just CEOs, investment bankers or asset managers. Interest rate changes can have an impact on everyday purchasing decisions, mortgage decisions or savings and investments.
For instance, the BoE’s rate was set at 5.25% today – an increase of 0.25% over the previous rate – in yet another attempt to keep inflation at 2%. But what does this mean in practice? The central bank rate is the rate at which commercial banks borrow money; it has increased, so that increase will feed into consumers in the form of higher interest rates on lending.
What is central bank signalling and why is it important?
It is becoming increasingly common for a central bank’s committee member to make comments on policy through committee meeting notes or statements, suggesting or signalling a central bank’s upcoming decision. This is called central bank signalling.
Until not so long ago, a non-specialist audience would be unlikely to hear what the Governor of the BoE or the Chair of the Fed had said in their latest statements. For the BoE’s Andrew Bailey, the Fed’s Jerome Powell or all their counterparts from other central banks around the globe, this is no longer the case. Moments after their comments are made, people around the world receive breaking news alerts on their smartphones. On the face of it, giving more people access to information faster may seem like a good thing.
However, there is a danger that whoever follows these news feeds could make material decisions with significant impact based on these remarks, such as fixing their mortgage, tying their savings up to a fixed-term deposit or investing/disinvesting from an investment.
Furthermore, central bank signalling does not represent an official decision, or even the central bank’s official stance. Different members of the committees may have different opinions on the future of monetary policy and therefore, signalling could lead an audience into making decisions based on a policy that a committee might not even implement.
As a recent example, Swati Dhingra, an external member of the BoE’s Monetary Policy Committee was quoted in The Guardian arguing that interest rates in the UK should remain at 4% to avoid a ‘material risk’ to the UK economy. You would be forgiven for thinking that this is a strong indicator that interest rates would not rise further. In fact, the BoE has raised rates four times since then, now standing at 5.25% at the time of writing this post.
Similarly, Deputy Governor Jon Cunliffe was quoted in an interview with the BBC in July 2022 saying that, while the Bank would do whatever it takes, “We can see signs that the economy is already slowing”. We have come a long way, very quickly since then.
This is not to say that these quotes were wrong or misplaced; these individuals were expressing their opinions based on the information they had at the time. But these examples show why it might be beneficial not to make decisions based on media reports, especially when these decisions concern you or your family’s financial future and influenced by your emotions.
What can you do?
These examples show the importance of being able to remain calm and not take everything you see and read at face value. And sometimes it is difficult to make the most effective decisions when emotion is playing a part in the decision-making process.
This is where having a trusted partner such as Partners Wealth Management can become invaluable in managing your finances. Our team of knowledgeable partners can distil information and rely on the relevant insights to make decisions with confidence.
The first step in Partners Wealth Management’s ‘Five Steps to Financial Freedom’ consists of creating a Lifetime Wealth Model. Creating and, most importantly, maintaining a Lifetime Wealth Model can help to remove the emotion from the decision-making process. Modelling the potential impact of changes on the likely success of your plans provides an impartial opinion on whether action is needed.
You can see more about the benefits of a Lifetime Wealth Model here.
If you would like further information regarding any of the points raised, please do get in touch with your usual Partners Wealth Management adviser, or, contact us on 020 7444 4030 or email@example.com.
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