Role of financial markets in monetary policy

For central banks, it is very important to know what economic agents, and more specifically financial market participants, think about monetary policy. Consequently, understanding financial market information represents an essential aspect of the MNB’s monetary policy decisions, because it is an influential component of risk perception in terms of the opinion of the members of the Monetary Council in relation to the inflation forecasts adopted on the basis of fixed conditions. Short-term interest rate expectations can be defined relying on the MNB’s estimate of the yield curve and market quotations. On the other hand, the analysis of long-term forward yields helps in drawing conclusions regarding the central bank’s credibility and market agents’ perception of the convergence process. For the assessment of foreign exchange market developments, the MNB relies on surveys concerning the equilibrium of the foreign exchange market and findings of the micro-structure theory. In order to identify the relation between exchange rates and yields, as far as the risk premium is concerned, shifts in risk appetite and default risks provide essential information, although the MNB frequently examines other factors as well.