Central Bank Communication and the Yield Curve

We decompose ECB monetary policy surprises into target and communication shocks and document a number of novel findings. First, consistent with the idea that concurrent implementation of monetary policy is largely anticipated, we find that target shocks only have a limited effect on yields. However, we show that communication shocks have a large and economically significant impact on sovereign yields, displaying a hump-shaped pattern across maturity. Second, we document that around the European debt crisis communication had the effect of driving a wedge between yields on core versus peripheral countries. We study two explanations for this finding, revelation of the ECB’s private information and credit risk, and argue that neither channel can explain the effect on yield spreads. Motivated by this, we consider an alternative explanation in which central bank communication affects the aggregate demand due to the presence of reaching-for-yield investors. We show that a resulting risk premium channel helps to rationalize our findings.