More than rate announcements, expectations for future monetary policy affect stock markets: RBI study

According to an investigation, expectations for future monetary policy have a greater influence on equity markets than unexpected changes in the policy rate on the day the Reserve Bank announces the policy.

A working paper written by RBI officials claims that the stock markets are also impacted by the development and regulatory initiatives that are launched in conjunction with monetary policy.

In line with the widely held belief that stock markets are forward-looking, the study found that changes in the market’s expectations of future monetary policy (the path component) had a greater impact on equity markets than policy rate surprises (target factor).

It said that “both target and path factors, as markets digest the policy announcements and traders adjust their portfolios throughout the day,” impact the volatility in stock markets on the day of policy release.

The Department of Economic and Policy Research of the Reserve Bank of India’s Mayank Gupta, Amit Pawar, Satyam Kumar, Abhinandan Borad, and Subrat Kumar Seet are preparing the RBI Working Paper on “Equity Markets and Monetary Policy Surprises.”

By breaking down changes in Overnight Indexed Swap (OIS) rates on the days of policy announcements into goal and path components, the article examines how monetary policy announcements affect the returns and volatility of the BSE Sensex. The route factor represents the influence of the central bank’s communication on market expectations on the future course of monetary policy, while the target factor captures the surprise element in central bank policy rate action.

The study observed that although the short duration windows are intended to account for other factors that can influence stock prices, it should be remembered that regulatory and developmental actions that accompany monetary policy pronouncements can also have an effect on the markets.

It also said that other local and international events within the short window, together with sometimes scant trade in the OIS markets, may potentially have an effect on the study.

The research spans the months of January 2014, when India implicitly adopted a flexible inflation targeting framework, through July 2022.

The RBI Working Papers series was launched by the Reserve Bank of India (RBI) in March 2011. The central bank said that the writers’ opinions are their own and may not necessarily reflect those of the institution or institutions to which they belong.