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Making sense of international interest rate movements

Hamish Pepper, Enzo Cassino

In this article, we describe a framework for analysing movements in government bond interest rates and present some results from applying this approach. Our framework disaggregates movements in nominal rates into estimated changes in real interest rates and inflation expectations. In addition, we discuss a measure of interest rate uncertainty, a factor which will often influence movements in these components. Since any long-term bond can be thought of as equivalent to a sequence of shorter-term bonds, we also calculate implied forward measures of each of these factors to better understand not only which factors are driving movements in nominal interest rates but also over which periods of time (i.e., current, future or some combination of the two) these factors are having an effect. We use the method to analyse movements in term interest rates in the US and the UK, two major markets with good data, since the global financial crisis intensified in 2008. It appears that the global financial crisis has had a largely temporary impact on longer-term measures of interest rate components: looking ahead, markets appear not to expect longer-term interest rates to be much different than they were prior to 2008. There are limits to our ability to apply these techniques directly to New Zealand markets, but the Reserve Bank of New Zealand uses them to help make sense of what is going on in international bond markets which in turn directly affect longer-term interest rates in New Zealand.