Praet Hits Back at Sirens in ECB Odyssey on Forward Guidance

(Bloomberg) -- Peter Praet said criticism of the European Central Bank’s use of guidance on the future path of interest rates is wrong because it fails to account for the nature of its commitment and how investors respond to that.

Even if the ECB’s signalling on the soonest moment when benchmark borrowing costs could rise doesn’t match the market’s view, that wouldn’t make any change in that message futile, its chief economist told an audience in Frankfurt.

ECB officials including Praet have signaled that they’re considering responding to the slowdown in the euro-zone economy by extending their forward guidance, which currently pledges not to raise interest rates before the end of the summer, and in any case not before the economy allows. Market pricing is currently converging on an increase only around the middle of next year.

“You should never forget that market expectations are very volatile, there is a distribution around expectations,” Praet said. “Some people say it’s later. Some people say it’s earlier.”

Praet emphasized the so-called Odyssean element of the forward guidance. When the ECB makes a minimum pledge on low rates, it’s not going to budge -- just like Odysseus, who tied himself to the mast of his vessel to resist the enchanting lure of the Sirens.

If you truncate the Odyssean part of the guidance, you truncate just the left part of the distribution. That makes a very big difference if you are a trader in the money market.

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