As regards the short-term predictability of monetary policy, policy moves have been pretty well anticipated by money markets. Recent studies by academics have confirmed the predictability of the ECB at the highest level amongst major central banks. Investors have indeed become more confident in their forecasts of future short-term interest rate developments prior to ECB monetary policy announcements. Bond market indicators paint essentially the same picture. Implied bond market volatility in the euro area is currently close to its lowest level since January 1999. Communication is an ongoing challenge Financial markets evidence indeed indicates that we as a central bank have managed to be understood by market professionals. But this is only part of the picture and should give no reason for complacency. We are well aware that earning people’s trust in the credibility of the ECB remains an ongoing challenge. And we know that the familiarity of the general public with the Eurosystem and the ECB still needs to be further enhanced. One indication of the daunting size of our communication task was the issue of so-called perceived inflation rising much higher than the actual measured inflation. It has turned out to be difficult to explain people that they should not judge the general price level just by observing the prices of some individual goods. We see the dichotomy of different target groups in the fact that there was at times a heated debate about deflation risks among financial analysts while at the same time the general public was deeply concerned about inflation.

The economic agents and the public need to be convinced that the central bank’s monetary policy decisions are consistently focused over time on achieving the announced aim. In a market-based economy the central bank can directly influence only short-term interest rates through its monetary policy instruments. However, consumption and investment decisions, and thus medium-term price developments, are to a large extent influenced by longer-term interest rates, which depend on private expectations regarding future central bank decisions and future inflation. It is important that these developments in longer-term rates support the objective of maintaining price stability over the medium term. This in turn requires that the central bank is regarded as credible and predictable. A central bank which does not succeed in communicating the principles underlying its monetary policy and is perceived as acting in a non-systematic, discretionary manner will over time endanger its reputation. Therefore, the central bank’s communication should ensure that markets understand the systematic responses of monetary policy to economic developments and the current assessment of the central bank. Successful central bank communication supports predictability and correct price formation in financial markets, contributes to efficient allocation of funds and reduces uncertainty about future interest rates. In an environment where the predictability of interest rate movements and their relation  BIS Review 5/2005  1  with key macroeconomic developments is well understood, firms can better manage their balance sheets. This reduces both their vulnerability to economic shocks and their risk management costs and creates the conditions for better investment decisions.