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Bank of England Interest Rate Announcements and the Foreign Exchange Market

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  • Michael Melvin
  • Christian Saborowski
  • Michael Sager
  • Mark P. Taylor

Abstract

Since 1997, the Bank of England Monetary Policy Committee (MPC) has met monthly to set the UK policy interest rate. We examine evidence of systematic patterns in exchange rate movements on MPC days over the first decade of operation of the MPC. Daily data reveal significant differences in volatility on the last of three meeting days when the interest rate announcement surprises the market. Intraday, five-minute return data are then used to provide a microscopic view. We use a Markov-switching framework that incorporates endogenous transition probabilities, which allows for an interesting alternative characterization of macroeconomic news effects on the foreign exchange market. We find evidence for non-linear regime switching between a high-volatility, informed-trading state and a low-volatility, liquidity-trading state. MPC surprise announcements are shown significantly to affect the probability that the market enters and remains within the informed trading regime, with some limited market positioning just prior to the announcement.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2009/wp-cesifo-2009-04/cesifo1_wp2613.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2613.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2613

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Keywords: foreign exchange market; microstructure; monetary policy announcements; Markov switching; endogenous probabilities;

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References

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  1. Gurkaynak, Refet S & Sack, Brian & Swanson, Eric T, 2005. "Do Actions Speak Louder Than Words? The Response of Asset Prices to Monetary Policy Actions and Statements," MPRA Paper 820, University Library of Munich, Germany.
  2. Michael J. Sager & Mark P. Taylor, 2006. "Under the microscope: the structure of the foreign exchange market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(1), pages 81-95.
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Citations

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Cited by:
  1. Christopher J. Neely & S. Rubun Dey, 2010. "A survey of announcement effects on foreign exchange returns," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 417-464.
  2. Christopher J. Neely, 2011. "A survey of announcement effects on foreign exchange volatility and jumps," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 361-385.
  3. Rosa, Carlo, 2013. "Market efficiency broadcasted live: ECB code words and euro exchange rates," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 167-178.
  4. Menkhoff, Lukas & Taylor, Mark P., 2006. "The Obstinate Passion of Foreign Exchange Professionals: Technical Analysis," Hannover Economic Papers (HEP) dp-352, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  5. Carlo Rosa, 2012. "How "unconventional" are large-scale asset purchases? The impact of monetary policy on asset prices," Staff Reports 560, Federal Reserve Bank of New York.
  6. Michael Ehrmann & Chiara Osbat & Jan Strasky & Lenno Uusküla, 2013. "The Euro exchange rate during the European sovereign debt crisis – dancing to its own tune?," Bank of Estonia Working Papers wp2013-3, Bank of Estonia, revised 24 May 2013.

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