The RBI working paper said that equity markets are more influenced by changes in market expectations about future monetary policy than by the interest rate surprise. File | Photo source: Reuters
Equity markets are more influenced by expectations about future monetary policy than interest rate surprises on the day the Reserve Bank announces its policy, the analysis shows.
According to a working paper prepared by RBI officials, regulatory and developmental measures announced along with monetary policy also impact equity markets.
“Equity markets are influenced more by changes in market expectations about future monetary policy (the path factor) than by the interest rate surprise (the target factor), which is consistent with conventional thinking that equity markets are forward-looking,” the article says.
It said equity market volatility on the day of a policy announcement is “affected by both target and path factors as markets digest policy announcements and investors adjust their portfolios throughout the day.”
The RBI Working Paper on ‘Equity Market and Monetary Policy Surprises’ was prepared by Mayank Gupta, Amit Pawar, Satyam Kumar, Abhinandan Borad and Subrat Kumar Seet of the Department of Economic and Policy Research, Reserve Bank of India.
Understanding the impact of monetary policy announcements on returns
This paper analyzes the impact of monetary policy announcements on the returns and volatility of the BSE Sensex by decomposing the changes in Overnight Indexed Swap (OIS) rates on monetary policy announcement days into target and path factors. The target factor takes into account the element of surprise in the action of the central bank’s monetary policy, while the path factor takes into account the impact of the central bank’s announcement on market expectations regarding the future path of monetary policy.
While short-term windows are intended to control for other potential factors affecting share prices, it can be seen that monetary policy announcements are accompanied by regulatory and development measures that can also impact markets, as stated in the article.
He added that limited occasional trading in OIS markets and other domestic and global events within a narrow window could also impact the analysis.
The analysis covers the period starting in India with the stealth adoption of the adaptable inflation targeting regime (January 2014) and ending in July 2022.
The Reserve Bank of India (RBI) introduced the RBI Working Paper Series in March 2011. The central bank has stated that the views expressed in the document are those of the authors and not necessarily of the institutions to which they belong.
