Crystal ball

ECB risks credibility with new long-range forecast

The European Central Bank plans to issue economic forecasts an extra year into the future. This may help justify its decisions and signal intent at a time its inaction is under attack. But it's playing with fire, and its credibility, given the risk of being wrong increases with time.

Starting in March, the central bank will issue forecasts for the two years beyond the current one, instead of just one. Long-range forecasts seem to make sense for a central bank that prides itself on avoiding twitchy reactions to data. Euro zone inflation is running at less than half the ECB's goal, of just under two per cent. It will only rise to 1.3 per cent in 2015, according to the central bank's own, latest forecasts. Policy inaction is easier to rationalise if inflation is expected to pick up further in 2016. Equally, the case for more radical measures could be made if inflation was expected to stay too low, or subside further. By extrapolation, revised predictions can give markets, companies and households a steer on the outlook for monetary policy.

The problem is that the longer the horizon, the shakier the forecasts. Hence the risk they become just a piece of data to justify the central bank's policy - whatever it may be. There are precedents. For years, the Bank of England's central scenario was that it would hit its two per cent target. For years it was proven wrong. But that seemed to matter less than being able to justify quantitative easing even when inflation was overshooting.

True, the BoE's poor track record didn't translate into an upward spiral in inflation expectations among the population at large. Nevertheless, the UK central bank paid a price. Financial markets now set limited store by its forecasts, either for inflation or for unemployment. That has made it harder for the BoE to guide traders' expectations and market interest rates.

Forecasts are at best a guess of how the world might turn out. They shouldn't be used as propaganda tools to justify monetary policy decisions.