Financial market volatility and economic policy uncertainty: bridging the gap

This box explores the relationship between financial market volatility and economic policy uncertainty (EPU). Historically, financial market volatility and news-based measures of EPU have displayed close co-movement, albeit diverging at times and across countries. More recently, the rise in euro area EPU has reflected an intensification of an upward trend observed over a number of years, largely driven by developments in Germany. Focusing on Germany and using a large language model, a topic-based analysis of newspaper articles identifies domestic and global uncertainties as being behind the recent surge in EPU. Moreover, in line with empirical findings for the United States, a regression analysis shows that a disconnect between financial market volatility and EPU is more likely when equity market momentum is strong, while co-movement is more likely when that momentum is weak. This interpretation is consistent with developments following the US tariff announcement on 2 April, when the spike in financial market volatility aligned with persistently high EPU levels on the back of a significant sell-off in equity markets. JEL Classification: D84, E44, G18