Central bank forward guidance, whether publishing rate forecasts or
promising rates will remain at certain levels for a given time or
until certain economic conditions are reached, has been in the
spotlight recently as economies recover from the financial crisis
and investors try to pick the beginning of the end of easy money
Research published in the BIS quarterly review found guidance from
the Bank of England, European Central Bank and U.S. Federal Reserve
had a calming influence on markets and also helped shield the UK and
euro zone economies from turbulence last year about when the Fed
slowing asset purchases.
But BIS economists said there were risks from markets focusing too
narrowly on certain aspects of forward guidance and from central
banks themselves potentially becoming too worried about markets'
reaction, to the extent that it could delay a return to more normal
This could "raise the risk of an unhealthy accumulation of financial
imbalances," the report said.
"Moreover, the mere perception of this possibility, over time, could
encourage excessive risk-taking and thereby foster a build-up of
financial vulnerabilities," the paper said, adding that it was not
clear whether forward guidance would become a permanent feature of
central bank communication or prove to be only useful in times of
For the Fed, introducing a pledge that rates will remain close to
zero until well past the time that the unemployment rate reaches 6.5
percent, as long as inflation does not threaten to rise above 2.5
percent, meant markets reacted less to the release of monthly
non-farm payrolls figures — but this would change as the threshold
"Interest rate futures are likely to become more sensitive to labor
market developments as the threshold is approached," the paper said.
The U.S. jobless rate ticked up to 6.7 percent in February, giving
policymakers some breathing room to consider how to adjust guidance.
But interest rate futures showed that traders ramped up bets after
Friday's data on the Fed raising rates a bit sooner than had been
The BoE faced a similar dilemma: last year, it said it would only
consider interest rate hikes when unemployment fell to 7 percent.
But with that threshold approaching, the BoE last month broadened
the focus of the guidance towards a wider assessment of spare
capacity, or slack in the economy.
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For its part, the ECB has vowed to keep interest rates "at present
or lower levels for an extended period of time."
A separate article in the report found non-U.S. banks had a
disproportionate share of reserves at the Fed since they found it
cheaper to raise wholesale funding than their domestic counterparts.
At the end of 2013, they held almost $1 trillion of the $2.2
trillion reserves, 43 percent of the total, compared to their 13
percent share of total U.S. banking assets.
But the paper said this could change if reverse repurchase
operations, a way to control short-term rates, were standardized as
part of the Fed's tool kit, especially if combined with a reduction
in the bond portfolio.
"For some banks, especially U.S. branches of non-U.S. banks, it
would reduce any profit to be made by taking in wholesale funds at
10 basis points (or less) and holding reserves at the Fed at 25
basis points. In effect, the new operations disintermediate the
banks that have done this low-risk trade," the paper said.
In reverse repos, the Fed temporarily drains cash from the financial
system by borrowing funds overnight from banks, large money market
mutual funds and others, and offering them Treasury securities as
(Reporting by Krista Hughes; editing by
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