FRANKFURT, Jan 25: The International Monetary Fund criticised the European Central Bank for confusing markets and said it was less predictable than its central bank peers, the US Federal Reserve and the Bank of England.

The ECB, currently reassessing its monetary strategy, has said that it does not want to surprise financial markets, but the young central bank still arrived in third place in the IMF’s empirical study, on which it declined to comment.

The US Fed was the most predictable central bank, followed by the Bank of England, the IMF said in a study posted on its Web site late on Thursday.

In the case of the ECB, the market has had difficulty anticipating ... large changes and cuts in policy interest rates, the IMF said, adding markets had shown a “mediocre” track record predicting ECB moves since it came into existence.

Looking at euro overnight interbank rates as a proxy to ECB rate changes, the IMF found markets could reliably predict an ECB move in just 44 per cent of cases. That compares to 60 per cent for the Bank of England and 100 per cent for the Fed.

Market participants and academics have often criticised the ECB, which sets interest rates in the 12 nations using the euro as their currency, for sending confusing messages, which has already caused changes to its communication policy.

The bank announced last month that it would review its so-called two-pillar monetary strategy framework that gives a prominent role to money supply growth as an inflation harbinger, though the review need not necessarily lead to changes.

Some ECB officials have since signaled they were not overly happy with the role of money supply growth in the bank’s policy, making the monetary gauge a possible candidate for adjustments in the policy revamp. But the bank did not consider changing its tight 2 per cent inflation ceiling, others have emphasized.

The bank’s overall predictability — when including no-change decisions — had been roughly as high as the Fed and Bank of England, the IMF said, in a sign that markets were well able to understand its two-pillar strategy.

A variety of monetary policy frameworks, be it inflation targeting, a uniquely continental European two-pillar system, or a more discretionary US model can be successfully understood by financial markets, the IMF said.

But the young central bank, still struggling to establish political independence, should not be judged too harshly, as financial markets were not its exclusive audience and it needed to send signals to politicians and wage negotiators, as well.

Moreover, its audience was in 12 different nations with varying political systems and diverging views on how monetary policy should function.

However, the overall hit rate — including decisions to leave interest rates unchanged — was 79 per cent, roughly the same as that of the other two banks in the study.

The IMF said four out of five interest rate cuts examined in the study had taken place when the bank’s monthly bulletin indicated a neutral bias. Markets had not been able to forecast a single one of those five easings.

An added factor (to explain the ECB’s low predictability) may be the absence of a consistent policy on communicating the current stance — if any — of the ECB’s policy bias on the future direction of interest rates, the study said.

Unlike the Fed, the ECB does not officially have a bias that indicates in which direction interest rates are most likely to move next, but the monthly bulletin contains language generally read as indicating something close to a bias.

To improve its communication with financial markets the ECB decided on interest rates only once a month in November 2001, as the two-weekly frequency with which it had met up until then was leading to continuous rate speculation and market volatility.

The specific structure of the euro overnight money market might be another reason why it was hard to read future ECB decisions from market prices, the IMF said.

Overnight rates tend to rise toward the end of each monthly reserve period because banks have less time to average out their central bank holdings, which might make it impossible for a rate cut signal to be discounted into those prices.

The bank has just announced plans to change the system.—Reuters