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Financial market reaction to monetary policy surprises

Monetary policy decisions that are not fully anticipated by financial markets (‘monetary policy surprises’) lead to changes in interest rates and the New Zealand dollar exchange rate.

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About the Analytical Note

Kia ora, I'm Rachael, a researcher here at Te Pūtea Matua.

Our new analytical note shows that monetary policy decisions that surprise financial markets lead to changes in interest rates and the New Zealand dollar exchange rate.
 
Material monetary policy surprises are where financial markets’ expectation and pricing of the Official Cash Rate - or OCR - immediately before an announcement is more than five basis points different from the actual announced rate. Material surprises are not common.
 
Since 2006, less than 1 in every 5 OCR announcements came as a material market surprise. In this chart here you can see a number of surprises, as shown in the red dots above and below the line.
 
For example, we can see this during the global financial crisis here.
 
We know that communication as a central bank helps monetary policy to be more effective.
 
So understanding the effects of surprises on financial markets is important for us here at the Reserve Bank.
 
We found that an OCR surprise that was ten basis points above expectations, would lead to a 0.5% rise in the New Zealand Dollar exchange rate, in the first hour after an OCR announcement.
 
We also found evidence that OCR surprises from Monetary Policy Statements have a slightly stronger and more persistent effect on financial instruments than surprises from Monetary Policy Reviews. This could be related to the larger information set published during Monetary Policy Statements.
 
To learn more, you can find the full research on our website.

A new Analytical Note measures monetary policy surprises and assesses their effects on financial market instruments. 

Understanding the effects of monetary policy surprises on financial markets is key given the importance of central bank communication and the role financial markets play in the transmission of monetary policy. 

The Analytical Note shows that material monetary policy surprises – defined as instances where market pricing for the OCR immediately prior to an announcement is more than 5 basis points different from the announced rate – are relatively rare. Since 2006, fewer than 1 in 5 OCR announcements resulted in a material monetary policy surprise (see red dots in Figure 1, below).

Figure 1: Monetary policy surprises: 2006 to 2023

Chart showing monetary policy surprises: 2006 to 2023
Monetary policy surprises: 2006 to 2023
This chart shows monetary policy surprises between 2006 and 2023, represented by the pink and grey dots. The pink dots represent the monetary policy surprises that were material.  A material monetary policy surprise is where financial markets' expectation and pricing of the OCR  immediately before an announcement is more than 5 basis points different from the actual announced rate. The grey dots represent monetary policy surprises that are non-material – that is financial markets' expectation and pricing of the OCR  immediately before an announcement is below 5 basis points different from the actual announce rate. The blue bars represent technical recessions during this time period – 2 consecutive quarters of negative growth.

This Analytical Note assesses the impact of monetary policy surprises on specific New Zealand dollar exchange rates, domestic interest rate swaps and their spread to equivalent swap rates offshore. The authors find that monetary policy surprises have a similar effect on the New Zealand dollar as found in our previous research. That is, a +10 basis point OCR surprise is associated with a 0.5% appreciation in the Trade Weighted Index (TWI) one hour after an OCR announcement. 

Additionally, this Analytical Note shows that there is some evidence that monetary policy surprises from Monetary Policy Statements have a slightly stronger and more persistent effect on financial instruments than surprises from Monetary Policy Reviews. This could be related to the larger information set provided in Monetary Policy Statements.

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