DO EUROPEAN CENTRAL BANK’S STATEMENTS STEER INTEREST RATES IN THE EURO ZONE?* by MARIE MUSARD-GIES IXIS Corporate Investment Bank and University of Orleans (LEO) In this study, we aim at testing whether press conferences held after the meeting of the European Central Bank’s monetary policy council steer market interest rates in the Euro zone. To meet this goal, we quantify the statements according to whether they are neutral, hawkish or dovish. We show, using a principal components analysis, that market interest rates react significantly to the bias in statements, and more particularly to changes in statements from one meeting to the next. Moreover, we find that the short end of the yield curve reacts more sharply to statements than the long segment: the effect of statements peaks on interest rates with a maturity of 6 or 12 months and is smaller for the longer maturities. Using non-parametric tests confirms our previous results. 1Introduction Recent studies highlight the role played by the Fed’s statements on the day of the Federal Open Market Committee (FOMC) meeting. ‘It’s not what they do, it’s what they say’: this was the sort of thing one could read in financial papers in 2004. 1 The statement that followed the 28 January 2004 meeting led to ‘record’ reactions in the Treasuries market: two- and five-year interest rates rose 21 and 25 basis points, respectively, in the half hour that followed the announcement (i.e. the largest moves recorded in the past 15 years). This excessive reaction was triggered by what the Fed had said, and not by what it had done: the decision to leave interest rates unchanged was perfectly expected by the financial markets, but the FOMC’s decision to delete the sentence ‘policy accommodation can be maintained for a considerable period’ and replace it by ‘the Committee believes it can be patient in removing its policy accommodation’ was interpreted by the financial markets as a signal that the Fed was going to tighten its monetary policy faster than what had been previously anticipated. In recent years, the general move in central banks to enhance their transparency has had the consequence of improving substantially the predict- ability of monetary policy decisions. Several papers document the extent to which US monetary policy has become increasingly open and transparent and how these moves towards greater openness and transparency have increased the ability of markets to anticipate policy actions. Thus, Poole and * I would like to thank Patrick Artus and Florence Beranger for their many valuable comments and suggestions. 1 Statements reported by Bernanke (2004b). The Manchester School Supplement 2006 1463–6786 116–139 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK, and 350 Main Street, Malden, MA 02148, USA. 116 Rasche (2000) and Poole et al. (2002) investigate the extent to which market participants anticipate Federal Reserve policy actions. Their most important finding is that not only is the market better able to anticipate funds rate target changes, but it appears that the market is able to anticipate such changes further in advance. In more recent papers, Lange et al. (2003) and Swanson (2004) conclude that a higher degree of transparency of the Fed is connected with a higher degree of predictability. In the Euro area, Perez-Quiros and Sicilia (2002) find that market interest rates have predicted Euro area interest rates comparatively well up to three months in advance. 2 Transparency of monetary policy allows financial markets to better anticipate the monetary policy decisions. As a result, the response of interest rates to the publication of macroeconomic data depends on the degree of transparency in the conduct of monetary policy. The theory of efficient markets predicts that the prices of financial instruments will always reflect all available information. If markets are efficient, interest rates should adjust virtually instantaneously after the release of data that modify financial markets’ expectations concerning monetary policy. Transparency therefore causes financial markets to adjust their interest rate expectations as soon as macroeconomic data are published, in advance of any action by the central bank. In this vein, Haldane and Read (2000) show that a reduction in the markets’ uncertainty about the central bank’s reaction function implies that market prices will react less to monetary policy changes since market partici- pants are better able to anticipate them and more fully to news about the state of the economy, in particular macroeconomic data releases on which the reaction function is conditioned. Consequently, markets react to macroeco- nomic announcements they view as important arguments to the monetary policy reaction function and, moreover, react more strongly to those unan- ticipated data releases that have greater impact on potential future monetary policy. Thus, in a world where the central bank’s reaction function was known to the market participants with certainty, one would in principle observe no financial asset price reactions at the time of monetary policy changes, but significant reactions to the release of surprise macroeconomic data that occur before the monetary policy action date. Insofar as monetary policy decisions are now largely predictable, and consequently well expected, one should ask what the role of central banks is in the implementation of monetary policy if financial markets are themselves able to digest and factor the new information into interest rates. Do central banks have the possibility to make monetary policy more effective? Clear communi- cation helps to increase the predictability of monetary policy decisions, and thus causes financial markets to adjust their interest rate very quickly and well 2 According to their approach, over the period between 4 January 1999 and 6 June 2002, which included 78 meetings of the Governing Council of the European Central Bank, the market correctly anticipated 94 per cent of the decisions. ECB’s Statements and Interest Rates 117 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 before the meeting on monetary policy. Nevertheless, are central banks able to go further in moving asset prices in the desired direction? Communication of the central bank has a real importance in this situa- tion (nearly perfect predictability) because it enables monetary policy to be more efficient. Indeed, to the extent that communication provides useful guidance to markets about the future path of short-term interest rates, central banks will exert greater influence over the longer-term interest rates that most matter for spending decisions. Actually, setting of short-term interest rates by the central bank has no more than a small impact on the investment decisions of the private sector insofar as the latter depend primarily on the level of long-term interest rates. However, the link between expectations about mon- etary policy and long-term interest rates is well known, e.g. theories about the term structure of interest rates such as the theory of expectations. Conse- quently, expectations about monetary policy are at least as important as the current level of short-term interest rates in terms of determining long-term interest rates—hence the role played by the central bank’s communication policy because the way it communicates is how it will be able to give its interpretation about trends in economic activity. In other words, if it is credible, the more the central bank provides information to the markets about how it assesses trends in inflation, in real activity etc., the more the expectations of financial markets and of the central bank will tend to align themselves with one another and, ultimately, the more the central bank will influence long-term interest rates. In this paper, we study the effect of European Central Bank (ECB) communication on interest rates of different maturities. More precisely, we aim at testing whether the statement made during the press conference that follows the announcement of the ECB’s decision about the main refinancing rate, for its part, has an impact on interest rates. To do so, we are going to look whether the tone of the ECB’s statement (which we are going to codify) or the change in the tone from the previous statement explains changes in the Euro zone’s short- and long-term interest rates. We briefly review, in Section 2, empirical studies on central bank communication. Section 3 then discusses the issue of how to measure communication. This is followed by our empiri- cal analysis of the effectiveness of ECB statements in influencing Euro zone interest rates in the desired way in Section 4. Section 5 presents the results. Section 6 concludes. 2Empirical Studies on Central Bank Communication The empirical literature 3 on central bank communication is quite small, partly reflecting the difficulty of measuring it, partly due to the relatively 3 References related to theoretical models estimating the impact of communication are older and numerous. We can refer to surveys on the transparency: the most recent is Carpenter (2004); other surveys are those of Geraats (2002) and Hahn (2002). The Manchester School118 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 recent adoption of transparency as a major characteristic of central bank policy. These papers analyze the effect of central bank communication on asset prices. Most studies test whether communication affects exchange rates: Jansen and de Haan (2003) find some effect from ECB statements on the volatility of the Euro and Fratzscher (2004) finds more systematic evidence in favor of effectiveness for the three G3 monetary authorities in changing the level and volatility in the desired direction. We will focus here on the impact of ECB communication on the yield curve. The first paper to analyze the effect of Fed communication on market rates is Kohn and Sack (2003). These authors use daily data and show that when the Fed holds a speech (statements that can be three types of commu- nication: statements by the FOMC Chairman Greenspan on the day of the FOMC meeting, testimonies and other speeches of Greenspan), then market rate variance (which corresponds to the volatility of the error term in regres- sions) is much stronger. This suggests that financial markets react to state- ments delivered by the Fed. Furthermore, Kohn and Sack (2003) distinguish two types of statements, depending on their contents: one referring to the ‘monetary policy inclination’ and the second one to the ‘economic outlook’. These authors conclude that statements by Greenspan about the monetary policy inclination have a significant effect on the volatility of short-term interest rates while statements about the economic outlook tend to have a significant impact on longer maturities. In the same vein, Bernanke et al. (2004) and Gürkaynak et al. (2004) find that US financial markets attribute considerable importance to statements that include an indication about the future path of policy. Ehrmann and Fratzscher (2005) analyze the communication strategies and assess their effectiveness for three central banks: the Fed, the Bank of England and the ECB. They focus on forward-looking policy statements (speeches, interviews and testimonies) delivered by all policy-makers (not only the central bank’s governor) distinguishing communication on meeting days from inter-meeting statements. Following the terminology also used by Kohn and Sack (2003), these authors decided to keep the categorization as simple as possible. They conclude that US markets react significantly more strongly to statements by Greenspan and less to statements by other FOMC members, whereas Euro area markets respond to communication by the ECB President and other Governing Council members to a very similar extent. Finally, they find that US markets react to statements both about monetary policy inclination and the economic outlook, whereas UK and Euro area markets respond mostly only to communication about monetary policy. 4 Finally, the paper of Rosa and Verga (2005), in a similar vein to our study, analyzes the communication content of ECB press conferences. These 4 This difference probably reflects, according to Ehrmann and Fratzscher, the different market perceptions of policy reaction functions. ECB’s Statements and Interest Rates 119 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 authors construct an indicator to capture inflation and real economy risks and conclude that market expectations at different maturities (from one to six months) react to ECB communications. This paper covers a short-term time horizon (from October 2001 to September 2004) that captures only a period of increasing interest rates. Moreover, the authors have limited their analysis to the meetings in which the ECB did not change the main refinancing rate. All these studies conclude that central bank communication has signifi- cant influences on the expectations of financial markets. The study of Rosa and Verga (2005) is most closely related to our approach. We extend this literature by analyzing the effect of ECB statements on the yield curve in order to assess if ECB communication affects the short end and the long end of the yield curve differently. 3Measuring Communication:How Do We Quantify the Contents of ECB’s Statements? In this section, we turn to the issue of how to measure communication. As our objective is to test whether and to what extent ECB’s statements affect market interest rates, on the day of the press conference that follows the announce- ment of the ECB’s decision about the main refinancing rate, we need to construct an indicator that quantifies the content of ECB communication. Contrary to Kohn and Sack (2003) and Ehrmann and Fratzscher (2005) who distinguish between ‘monetary policy inclination’ statements and ‘eco- nomic outlook’ statements, we have codified all the statements made at press conferences from 1999 to October 2004 (i.e. a statement per month generally speaking) by drawing a distinction between statements with a ‘hawkish’ (i.e. statements that seemed to indicate that future policies might involve higher rates than previously thought), ‘very hawkish’, ‘neutral’, ‘dovish’ (i.e. state- ments that seemed to indicate that future policies might involve lower rates than previously thought) or ‘very dovish’ tone. An indicator variable (D ECB ) takes the values +2, +1, 0, -1 and -2 according to the tone of the statement. At each press conference, the ECB discusses the prospects with respect to how prices will trend in the medium term (as its main objective is medium- term price stability) via several dimensions: it analyzes and directly antici- pates trends in consumer prices (moves in energy prices, prices of food goods, wages etc.) but also in real activity and in the money supply via growth in monetary aggregate M3. 5 In its introductory statement, the ECB therefore presents its inflation and growth scenarios, as well as the implicit (upside or downside) risks for its central scenarios. It is by drawing on these scenarios 5 A noteworthy point is that the structure of the press conference changed from May 2003 onwards. From 1999 to April 2003, risks weighing on medium-term price stability were analyzed by drawing on two pillars (pillar one, trends in M3; and pillar two, a collection of indicators having an impact on prices). Subsequently, from May 2003 onwards, the two pillars were replaced by economic analysis and monetary analysis. This does not modify our codifying work, however. The Manchester School120 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 and associated risks that we ascribe a ‘rating’ to the statement (e.g. a scenario of growth equal to its potential with upside risks and a rise in inflation and with also upside risks in the medium term will be deemed very hawkish). Rosa and Verga (2005) use specific expressions or code words that are used frequently in the ECB press conference in order to translate the quali- tative information into an index. Nevertheless, their indicator relies only on the ‘synthetic judgments’ part of the introductory statement 6 and most of the time the synthetic judgment is only a small part of the whole communication. Consequently, this quantification by only some expressions has some draw- backs: some very important but uncommon expressions can be missed by an automatic analysis. Moreover, a precise coding would require an analysis of the grammatical structure of sentences: indeed, meaning and strength of keywords often depends on the context of the sentence. Another study is the one of Gerlach (2004): it relies on the editorial of the ECB monthly bulletin. This analysis is a more subjective one: he does not construct a glossary of words based on a few lines only to construct an index. For each editorial, using information synthesizing the overall reading of the editorial, he allocates a different value to the three dimensions: inflation, real activity and M3. Consequently, this approach allows reading ‘between the lines’ and therefore is more subjective than the systematic approach of Rosa and Verga (2005). Our study is based on two coding principles merging these preceding ideas. First, one is like the Rosa and Verga (2005) study with some slight differences: it relies on the automatic analysis of the keywords of the whole ECB press conference (and not only on the synthetic judgment). A corpus of vocabulary often found in ECB statements has been defined automatically (by analysis of the statements with a computer), and each word or expression of this corpus has been assigned a weight (negative in the case of a dovish one, positive in the case of a hawkish one). The corpus is used to approximately quantify the tone of the communication. However, precision of this codifi- cation is limited for the reasons detailed above. Consequently, this first coding, which can be considered as a global trend of the tone of the ECB statements, is refined in order to improve the quality of the analysis. We use an additional coding system more related to the Gerlach (2004) approach. The automatic coding defined before is improved when some important ‘triggering’ sentences are present (not only keywords, the whole sentences are important to understand that there is a real change in the tone). For example, the press conference of February 2000 is coded as +1 and the press conference in March 2000 is coded as +2 because in March the ECB added the ‘trigger- ing’ sentence: ‘the Governing Council concluded that vigilance is required’ (it 6 Rosa and Verga provide in their paper a description of how an ECB press conference is organized: after some greetings, there is a synthetic judgment on the risk for price stability, followed by a judgment on growth, inflation and monetary variables. At the end of the introductory statement, the synthetic judgment is repeated. ECB’s Statements and Interest Rates 121 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 was the first time that the ECB used this word to express its concern about inflation risk). This explains why we changed the status of this press confer- ence to very hawkish. Actually, what we are coding in this second step is the change in the tone from one meeting to the other one (‘differential’ coding). Obviously, this operation is more subjective and for this reason coding has been done by two persons, comparing and merging the results after. Our study covers a time horizon from January 1999 to October 2004, 7 which yields 66 observations (on the other hand, the Rosa and Verga (2005) study is based on only 30 observations). The final codification we obtain is presented in Appendix A (Table A1). We compared (Appendix A, Fig. A1) our codification of statements with that carried out by Gerlach (2004). We take the sum of the ratings set by Gerlach or calculate a weighted average (with larger weight for ‘activity’ and ‘inflation’ ratings, i.e. 40 per cent, than for the rating relative to M3, i.e. 20 per cent). We conclude that our assess- ment of ECB statements is quite similar to the one drawn upon by Gerlach when we look at the weighted average of his ratings. The only major differ- ence concerns 2004, when ECB statements were relatively hawkish in our opinion, while he deems them to have been neutral. Note that the tone of ECB statements (Appendix A, Table A2) is more often hawkish than accommodating even though, in four out of the six years of observation, growth in the Euro zone was lower than its potential growth rate (for the ECB, potential growth is close to 2–2.25 per cent). Simulta- neously, the inflation target has exceeded 2 per cent every year except in 1999 (and inflation is the objective of the ECB’s monetary policy). 4Data and Methods We aim at testing whether information from the ECB’s press conferences have effects on financial market expectations, i.e. whether day-to-day change in short- and long-term interest rates around the ECB meeting is related to the tone of the statement. We use approaches that are common in the ‘event- studies’ of finance literature: ordinary least squares regressions analysis, where ECB statements are represented by our dummy D ECB that codifies the tone of the statement, and non-parametric tests in order to test the robustness of our previous results. The studies conducted in the USA and reviewed in Section 2 use intraday data and therefore assess the impact of the Fed’s statement in the minutes just after the statement. 8 We use daily data since our objective is to test whether the statements have a durable impact on interest rates. It is normal that the markets should react to a macroeconomic figure or a statement: conse- 7 No press conference is held in August. Furthermore, two press conferences were held in March and October 2000, and this explains why there were 13 press conferences in 2000 instead of 11 in the other years. 8 Only Kohn and Sack (2003) use daily data. The Manchester School122 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 quently, asset prices move in the wake of announcements. However, what we would like to ascertain is whether the initial reaction lasts a few hours and is always factored into interest rates at the end of the day. To do so, we calculate, for each interest rate we consider, the difference between the inter- est rate on the day of the monetary policy council meeting and the interest rate on the day before the Governing Council meets (closing price) to test whether ECB communication affects the term structure of interest rates. In other words, for each ECB meeting, we calculate the day-to-day reaction of interest rates at different maturities. Moreover, we are interested in the effect of ECB communication on the Euro zone’s short- and long-term interest rates, in order to test whether the effect of ECB communication is different, depending on the maturities. For our analysis, we have therefore chosen to focus on several money market rates, in other words, the one-month Euribor, three-month Euribor, six- month Euribor and 12-month Euribor spot rates. With respect to long-term interest rates for the Euro zone, we use the price of German futures contracts (which are the benchmark of the Euro zone yield curve), two-year (Schatz), five-year (Bobl) and 10-year (Bund) rates. A future contract is a binding agreement between two parties to make a particular exchange on a specified date t in the future. 9 The interest of working on contracts (for the long segment) rather than spot rates lies in the fact that, generally speaking, futures are far more reactive (and thus factor in any additional information far faster). All these data (Euribor spot rates for the short end and futures contract for the long end of the yield curve) can be downloaded from Datastream. 10 In the event-study literature, authors regress the change in asset prices on the change in policy rate: 11 ΔΔRk ttt =+ + αβ ε (1) where DR t stands for the change in asset prices and Dk t stands for the change in monetary policy rate. For example, in Cook and Hahn (1989), Dk t stands for the change in the Fed Funds target rate: they examined the day-to-day response in the USA of bond rates to changes in the target Fed Funds rate from 1974 through 1979. The response to target rate increases was positive and significant at all maturities, but smaller at the long end of the yield curve. Results for more recent periods show a much weaker relationship between 9 A future contract is very similar to a forward contract, which is also a contract to trade on a future date. The main differences are that futures are always traded on an exchange, whereas forwards always trade over the counter. Furthermore, futures are highly standard- ized, whereas each forward is unique. 10 The future price is quoted on a daily basis for the delivery months March, June, September and December. A future continuous series can be calculated from the traditional traded months: we use the continuous series (calculated by Datastream) that smoothes the series during the switch over period from one month to another based on trading activity. 11 The sample consists only of days of central banks’ meetings. ECB’s Statements and Interest Rates 123 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 target rate changes and other interest rates (e.g. Roley and Sellon (1995) apply the Cook and Hahn event-study approach to the 1987–95 period). Similarly weak results for the 1989–92 period were obtained by Radecki and Reinhart (1994). This apparent deterioration of the relationship between target rate changes and market interest rates can be explained by the general move in central banks to enhance their transparency. This is why Kuttner (2001), in a context of enhanced transparency of central banks, has perfected the approach of Cook and Hahn. Using the Fed Funds Futures to identify the expected and the unexpected component of the monetary policy decision, he documents a much stronger relationship between market rates and un- expected changes in the funds rate target. Finally, if we suppose that monetary policy is perfectly predictable, the surprise on the day of the monetary policy meeting is no longer provided by the decision about the policy rate, but rather by the content of the statement of the central bank. Indeed, in the Euro zone, as underlined in the introduc- tion of this paper, market interest rates have predicted Euro area interest rates comparatively well up to three months in advance. 12 Bernoth and von Hagen (2004) conclude that the policy decisions of the ECB have been pre- dictable on average: they show that, since May 2001, markets were not surprised by the decisions on the rates of the ECB. However, we have to note that in May 2001 the ECB decision was largely unexpected. As soon as early 2001, the markets were expecting a rate cut by the ECB. Nevertheless, the ECB did not change its key interest rate in February, March, or even in April 2001, whereas the economic slow- down seemed to justify a rate cut (inflation was admittedly still high despite the fall in oil prices and was picking up again in March–April but this was mainly the result of the mad cow disease, i.e. an external supply shock). Even as the markets were banking on a rate cut, the ECB’s statements remained neutral. The fact that its statements did not change from one month to the next should not have led to fluctuations in interest rates and yet they were trending downwards: at this point in time, the markets believed in economic indicators more than in the ECB. In fact, it eased its monetary policy in May, thus comforting the markets, while still making rather neutral statements, as inflation had precisely peaked in this month at its highest level since the launch of the European Monetary Union at 3.1 per cent (but 3.4 per cent according to its measure at the time, which was subsequently revised). Consequently, in order to take into consideration the fact that a few monetary policy decisions were not perfectly expected, we estimate the day- 12 In this regard, the decision of the Governing Council of the ECB in November 2001 to switch from bimonthly to monthly discussion of monetary policy may have affected the predict- ability of the ECB, as the timing of its interest changes can be anticipated more easily by the market. The Manchester School124 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 to-day change of interest rates as a function of two different components: first, the unexpected component of the monetary policy as introduced by Kuttner (2001), and second, the informational content of central bank state- ments. Rosa and Verga (2005) include in their regression the actual change in the ECB policy rate on the day of the press conference. For the reasons explained above, the actual change in the ECB main refinancing rate is not consistent with the fact that markets are able to anticipate most of ECB decisions before the meeting. This is the reason why we prefer to include a measure of the unexpected change in the policy rate (the ‘surprise’ in mon- etary policy decisions) rather the actual change in policy rate the day of the ECB meeting. This yields the following equation: 13 ΔRa D S tttt =+ + + βγε ECB, (2) where D ECB stands for our dummy that quantifies the tone of ECB’s state- ments and S stands for the unexpected component of the monetary policy decision (called the ‘surprise’ of monetary policy). The question, then, is how to extract a measure of the surprise. We need to use forward interest rates in order to extract financial market expec- tations. More precisely, we will look at forward interest rates one week before the day of the press conference and compute a surprise as the dif- ference between the ECB main refinancing rate on the day of the meeting and the forward rate one week ahead. A forward interest rate is an interest rate that is specified now for a loan that will occur at a specified future date. 14 A standard assumption holds that a forward interest rate is the sum of two components: first, a liquidity premium (also called a term premium); second, an expectation concerning the spot rate that will hold at the time. Thus, a one-week rate one week forward of x per cent might be considered to be a consensus expectation of market participants that the one-week spot rate will equal x per cent in one week (the liquidity premium is considered to be insignificant for a maturity of one week). The underlying concept of this assumption is the so-called expectations hypothesis of the term structure: two equivalent investment options should have the same expected return, other- wise investors would arbitrage away any differences. With the exception of a term premium, there should be no difference in the returns from holding a long-term bond or rolling over a sequence of short-term bonds. To compute a forward rate, we use the following formula: f dd = − − FV 1 360 21 (3) 13 Note that the index t does not have a specified frequency. The subscript t denotes the day of a meeting (and only these days). 14 The interest rate is termed a forward interest rate to emphasize the fact that it covers an interval that begins at a date forward (i.e. in the future). ECB’s Statements and Interest Rates 125 © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 [...]... extract the common information contained in interest rates around the date of the statement PCA consists in projecting the n daily changes in the interest rates we consider (Euro zone short- and long-term interest rates) on the basis of n vectors (orthogonal with one another) Centering and reducing data prevents the more volatile series from ‘crushing’ the estimate Furthermore, this enables us to interpret... the relative weight of each interest rate in the axes derived from our PCA Initially, we carry out a PCA on all interest rates (short- and long-term interest rates) , and then we subsequently carry out a PCA on short-term interest rates exclusively and then on long-term interest rates 5.1.1 Interest Rates React Far More to the Change in the Tone from One Statement to the Next Than to the Statement in. .. carry out the PCA of changes in short- and long-term interest rates, we obtain a first factor that explains 52 per cent of the variance of all the changes in short- and long-term interest rates This factor is well linked to all the changes in short- and long-term interest rates: the weights of each market interest rate in the first principal component range between 0.34 and 0.43 if we look at the first... and Interest Rates 131 the longer end:16 short-term maturities are more significant Furthermore, the explanatory power of ECB communication for changes in interest rates is higher for short-term than long-term rates 5.2 Differentiated Impact of Statements According to the Maturity of Interest Rates After using the PCA to study the impact of the press conferences of the ECB on short-term interest rates, ... when the tone of ECB statements is less hawkish (or more accommodating) This result seems logical Financial markets are interested in the contents of the speech delivered by the ECB the day when the Governing Council meets: if the tone of ECB in comparison with the tone of the previous month becomes more hawkish, then market interest rates react more strongly (insofar as in ation is the objective of the. .. long-term interest rates and interest rates considered overall, we complete this analysis by studying separately the effect of our statement variable on interest rates at different maturities We have already shown that the statements had a more pronounced impact on the group of short-term interest rates than on the group of long-term interest rates Now, we will look for the horizon (among short-term interest. .. to dovish, interest rates will then trend downwards The markets do not react so much to the statement in absolute terms as to changes in the statement Thus, if the statement is hawkish after a monetary policy council and remains hawkish at the meeting of the © 2006 The Author Journal compilation © 2006 Blackwell Publishing Ltd and The University of Manchester 2006 ECB’s Statements and Interest Rates. .. (8) Finally, we find that ECB communication has no effect on the slope yield curve: short- and long-term interest rates react to the content of the introductory statements of the ECB press conference Now, we will use the same methodology to refine our analysis in order to assess the differentiated effect of ECB statements first on short-term interest rates and then on long-term interest rates 5.1.2 The. .. significant: the ECB’s statements therefore do have an impact on the Euro zone’s shortand long-term interest rates as they result from the main component Regarding the sign of the coefficient of our dummy variable, it is positive, and this clearly means that when the statements are hawkish (codes +1 or +2) shortand long-term interest rates tend to rise, and, vice versa, when the statements are dovish (codes... using the one-week and the one-month Euribor spot rates (by assuming that the difference between one-week and three-week interest rates is insignificant) The measure of the surprise in policy rate on the day i of the press conference is given by Si = ri − fi −7 (5) where the index i denotes here the day of the ECB meeting and has a daily frequency and ri stands for the new (i.e after the decision of the . contained in interest rates around the date of the statement. PCA consists in projecting the n daily changes in the interest rates we consider (Euro zone short- and long-term interest rates) on the. testing whether press conferences held after the meeting of the European Central Bank’s monetary policy council steer market interest rates in the Euro zone. To meet this goal, we quantify the statements. period of increasing interest rates. Moreover, the authors have limited their analysis to the meetings in which the ECB did not change the main refinancing rate. All these studies conclude that central