The impact of inflation news on financial markets

Quarterly Bulletin 1999 Q1
Published on 01 March 1999

By Michael Joyce of the Bank’s Structural Economic Analysis Division and Vicky Read of the Bank’s Foreign Exchange Division.

These announcements are decomposed into their expected and unexpected, or ‘news’, components using survey data on financial analysts’ inflation expectations. It is found that markets are efficient, in the sense that asset prices do not respond to the expected component of RPI announcements. Generally, only government bond prices appear sensitive to inflation news—particularly after late 1992, when the United Kingdom adopted an explicit inflation target. The responsiveness of implied medium and long-term forward inflation rates after 1992 is consistent with the ‘expected inflation hypothesis’, a finding that suggests that the pre-independence inflation-targeting framework was not seen as fully credible by the financial markets. But the declining responsiveness of bond yields and implied forward inflation rates to inflation news over the period of operation of the framework suggests that its credibility improved over time.

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