Interest rate shock could kick-start stock exchange

Aug 04, 2009

Norges Bank surprised most experts by cutting the interest rate by as much as 1.75 percentage points during the final interest rate meeting in 2008. Surprise interest rate changes like this, so-called interest rate shocks, can cause major changes in stock prices. 

Professors Hilde C. Bjørnland and Kai Leitemo of BI Norwegian School of Management have conducted an extensive study of the interaction between U.S interest rate decisions and the stock market (S&P 500) over a 20-year period from 1983 to 2002. 

The results of the study are now being published in the venerable international science periodical Journal of Monetary Economics.

Interest rate increase slows down stock exchange

”A surprise interest rate cut of one percentage point can send stock prices up by seven to nine percent,” says Bjørnland, professor of economics at BI Norwegian School of Management. This is a stronger link than in other similar analyses of data from the US.

Similarly, a surprise interest rate increase will be not be well received by the stock market, and can trigger a stock price fall of seven to nine percent.

So it is not surprising that interest rate decisions by Norges Bank are followed with great interest, not only by journalists and people with large mortgages, but also players in the finance markets. 

However, not all interest rate changes have this effect on stock prices. This is valid only for unexpected interest rate changes. An expected increase in interest rates will already be taken into account in stock prices, and as such, not affect them.

“Our analysis of the U.S. data indicates that 40 percent of the interest rate changes over this 20-year period came as a surprise to the market. This indicates that changes to the interest rate significantly affect stock prices,” Bjørnland says. 

However, she stresses that these are only temporary effects. In the long term, stock prices are mainly influenced by the company’s productivity.

Stock prices can affect interest rates

But it is not only surprise changes to interest rates which can have an impact on the stock market. In a similar manner, surprise changes in the stock market can affect the interest rate market.

A surprise stock price drop of ten percent could result in an immediate interest rate cut of 0.40 percent, according to the study. Over the course of six months, a drop in stock prices could cause interest rates to be cut by a full percentage point.

The Bjørnland/Leitemo study differs from previous studies in that it to a greater degree looks at the interdependence between interest rate decisions by the central bank and movements in the .

Source: BI Norwegian School of Management

Explore further: Family financing is anything but foolish

add to favorites email to friend print save as pdf

Related Stories

ND Expert: Fed’s rate cut risky for future

Jan 23, 2008

With the biggest one-day reduction of interest rates in history announced Tuesday, the Federal Reserve’s attempts to resuscitate the U.S. economy could be a mistake, according to University of Notre Dame economist Nelson ...

Internet trading's risks to Japan stocks

Oct 05, 2005

Japanese investors have been euphoric over the past few weeks as the stock market continues to grow from strength to strength amid growing optimism about the country's economic outlook. Yet the surge in share prices is not ...

Recommended for you

Family financing is anything but foolish

19 hours ago

Borrowing money from a family member or friend to start a business is often considered dangerous, both financially and emotionally, however new research conducted by an entrepreneurial expert at the University of Adelaide ...

The economics of age gaps and marriage

Oct 30, 2014

Men and women who are married to spouses of similar ages are smarter, more successful and more attractive compared to couples with larger age gaps, according to a paper from CU Denver Economics Assistant Professor Hani Mansour ...

Do financial experts make better investments?

Oct 28, 2014

Financial experts do not make higher returns on their own investments than untrained investors, according to research by a Michigan State University business scholar.

Lack of A level maths leading to fewer female economists

Oct 28, 2014

A study by the University of Southampton has found there are far fewer women studying economics than men, with women accounting for just 27 per cent of economics students, despite them making up 57 per cent of the undergraduate ...

User comments : 0

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.