10 December 2001, 17:44  : How predictable is the European Central Bank?

By Ruth Pitchford

The euro-zone's central bank has often been accused of wrong-footing financial markets in its three brief years of existence, but analysts may be better at calling its interest rate moves than they think.
The market consensus, reflected in polls, has proved correct on the outcome of 85 percent of the 71 monetary policy meetings the European Central Bank has held since January 1999.
Over the same period the polls were 91 percent accurate for the U.S. Federal Reserve, widely viewed as the most transparent of the major central banks, and just 78 percent correct on the Bank of England, which draws much less criticism than the ECB.
Accurate means the polls forecast correctly whether the banks would move rates and, if so, by how much.
So why do so many express frustration with the ECB, accusing it of choosing to keep the market guessing rather than offering carefully coded guidance like Fed chairman Alan Greenspan?
"The results (of the poll analysis) don't match market perceptions," said Sarah Hewin at American Express in London.
"The problem has been that, unlike the Fed and BoE, the ECB has given a couple of 'wrong' pointers to the markets, which people resent and remember all too clearly."
And the big upsets over ECB policy have been recent. The polls made the wrong call on Bank of England moves five times in 1999 but have got most British rate decisions right since then.

GREENSPAN THE 'MAESTRO'
Memories are much more raw of what happened this April, when the ECB failed to make a widely-expected cut, and again in May, when the cut came just when the market had stopped looking.
And indignation reached a peak on September 17, when the ECB followed the Fed with a half point cut just hours after ECB President Wim Duisenberg seemed to dismiss any early move.
"It's all down to basic, good public relations," said David Brown at Bear Stearns in London. "That's why Greenspan is the maestro and Duisenberg has a lot of learning to do."
Many struggle to interpret the ECB's official explanations of its motivation.
Some believe the bank feels compelled by its mandate to talk about its formal monetary policy "pillars" -- M3 money supply and the inflation outlook -- and remain silent about its genuine concerns for economic growth.
That might explain why polls have so often underestimated the ECB's willingness to make big interest rate cuts.
Four times the consensus has erred in forecasting quarter point moves when the ECB has opted for half point cuts instead.
"Although the decisions taken may on average be correct, the ECB has not so far managed to give convincing explanations," said Michael Schubert at Commerzbank in Frankfurt. "Their communication policy is confusing rather than informative."

HAWKS VS DOVES
Maybe that's due partly to strong tensions among the ECB's 18 decision-makers, drawn from 12 nations.
The perception that the ECB is hard to call may also reflect some reluctance in the markets to accept that the specialist ECB watchers have got it right.
And then there's the statistics.
Are the poll results a valid guide to how easy it is to predict ECB moves? For instance, do the raw data reflect the fact that the ECB meets much more often than the others?
To the markets' relief, the ECB said in November that it would only discuss monetary policy once a month. But until then, analysts had to forecast ECB policy twice a month, the Bank of England monthly and the Fed only every six weeks.
So to compensate for the much bigger sample of ECB polls, why not try comparing the raw accuracy ratings of the surveys with a simple forecast that rates would never change?
Well, if you'd predicted the ECB would never change rates in the past three years, you'd have been 83 percent correct.
If you had collated the views of experts who had analysed economic conditions and ECB thinking -- as the polls do -- you'd have been right 85 percent of the time.

WORTH THE EFFORT?
And you might ask: was it worth the effort?
Using this measure, the Fed shines. The "no change" forecast would have been the right call for only 48 percent of Fed meetings, while the panel proved 91 percent accurate.
And Bank of England experts would have scored well too, calling 78 percent of decisions correctly compared with only a 61 percent success rate for sticking to "no change".
But that comparison may not be fair to the ECB. The measure favours central banks like the Fed, which has used more of its meetings to change rates -- not necessarily a good thing.
Come to that, is predictability a good thing? Not always.
Economists agree that certainty about central bank policy does reduce market volatility and risk premiums, making it cheaper and easier for companies and consumers to do business.
"Also, confidence in the central bank can be key in times of difficulty -- witness...the market's view that the economy is in safe hands with Greenspan," said Hewin at American Express.
But markets have their own concerns and their interest rate calls don't always reflect what's best for the broader economy.
"There are times when a surprise element is needed," said Kirit Shah at Sanwa International. "In some instances market expectations can be a very poor guide to policy."

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