Most Credible Central Bank?

One of the main functions of global central banks is their forward guidance regarding the monetary policy they are conducting. Central banks’ projections and forecasts explicitly published in relevant statements and releases as well as implicitly transmitted via verbal communication of their leaders are also of very significant influence on many currency traders, but how credible are their words? Can Forex traders blindly follow the promises of central bankers, or shall we always anticipate surprises and exploit market reaction?
I will try to address those questions by outlining some of the main traits of the major central banks in relation to their trustworthiness in the recent time.
Federal Reserve could be a good example of a credible central banking authority, which tries to avoid delivering false promises. It could be, if not for the recent confusion with September 18 meeting, which should have resulted in tapering according to market participants. During the summer, Ben Bernanke and the whole FOMC have been preparing markets for a soon-to-come QE tapering creating false expectations and wreaking havoc when no-taper was actually announced. Another issue is with Fed’s constant change of interest rate raise conditions: going from no particular conditions to setting some distant term, to setting an unemployment rate threshold, to finally telling markets that reaching the threshold does not necessary mean a rate hike. Although all this may seem not too important, it is the Fed’s credibility, which is at stake. If traders cannot believe in what the central bank says, it loses control over its forward guidance tool.
European Central Bank appears to be in a bigger trouble trust-wise. Mario Draghi‘s pledge to do “whatever it takes” to lower the borrowing costs of the eurozone’s indebted nations in 2012 came in stark contradiction with his previous statements, which implied that it is the European bailout funds that should drive up the bonds’ prices. Although such powerful commentaries help with some immediate price tuning, they are destructive for the central bank’s reputation and thus credibility.
Bank of England reputation may still remain somewhat stained from George Soros’ attack of more than 20 years ago, but lately, the institution can be named one of the few showing little surprises. Although Mark Carney‘s postponing of the interest rate hikes could be named as a surprise by media, in reality, only few market participants did not expect the slow economic recovery to affect the interest rate change process. A sudden refocusing on the housing bubble is another issue that can cast a bit of shade on the bank’s communication integrity.
Bank of Japan uses all sorts of market manipulation tools: verbal interventions, actual quantitative easing, aggressive stimulus measures, etc. After all, it is hard for a monetary authority to operate within open markets when its main tool (interest rate) is already near zero for the past two decades. The problem with BoJ’s usage of non-traditional tools is that the markets hardly believe in words. Up until 2012, whenever there were talks by Japanese officials about the overpriced yen, the currency weakened only for some limited period of time and then continued its long-term rally. Big traders simply learned to ignore unbacked words coming out of Japan. Another issue with BoJ is the question of their independence. In reality, it looks like the monetary policy is often dictated by the Minister of Finance (and thus influenced by the country’s Prime Minister), which is hardly a credibility signal when governments may change each other multiple times per year in Japan.
Swiss National Bank is a black sheep among other major banks. It is the only developed nation’s central bank that conducts a clearly manipulative and blatantly protectionistic policy, while other developed nations are turning blind eye on it. Although its weak side is well characterized by the series of failed verbal interventions during 2000’s (in order to weaken over-appreciating franc), its credibility was strongly confirmed by setting and keeping the 1.2000 EUR/CHF floor rate in September 2011. A brief breach of the floor level in April 2012 caused some market panic, but it was the only time when SNB failed to hold its word since floor’s introduction.
Bank of Canada is certainly out of focus of the majority of Forex traders (after all it accounts for less than 5% of all FX trade volume), but it is one of the most consistent and predictable monetary policy setter among developed nations. When it changes its tone from hawkish to dovish or vice versa, it does it gradually. It does not offer too precise forecasts of its own rates, so it can hardly disappoint market participants. It is one of the rarer cases, when one can certainly believe all the bank says about its policy.
Reserve Bank of Australia is full of surprise rate cuts and hikes. Almost every board meeting results in something barely expected by the currency traders. However it also looks like no one really expects any predictability from RBA. Despite its developed status, Australia’s economy is strongly connected to the Chinese unstable growth and fluctuations in global demand for commodities.
Reserve Bank of New Zealand has a much better record of acting in accordance with its communications compared to the reserve bank of its western neighbor. They rarely do anything unexpected except for the times of global financial turmoil when everyone else has to act unexpectedly too. The problem is that not too many traders are concerned with RBNZ credibility — NZD is just 10th most-traded currency.
So what is your opinion on central banks’ credibility (or lack of)?

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