By Michael Joyce and Andrew Meldrum of the Bank's Monetary Instruments and Markets Division.
This article discusses various financial instruments that can be used to infer the Bank Rate expectations of financial market participants and examines how well these measures have predicted Bank Rate in the past. It also examines the role of model-based and survey information in assessing financial market Bank Rate expectations. The article suggests that it is important to adjust market interest rates for credit, liquidity and term premia when inferring expectations. It finds that credit and liquidity premia can largely be accounted for, either through the choice of financial instrument or by making some simple adjustments. Although recent advances in term structure modelling provide some useful techniques for adjusting for term premia, there is considerable uncertainty about how robust they are. It remains prudent therefore not to rely on any one measure and instead to use a variety of methods and information for this purpose.
Market expectations of future Bank Rate