The impact of monetary policy announcements by the South African Reserve Bank on stock market returns using forward rate agreements

Abstract

The objective of this paper is to explore the unanticipated impact of monetary policy announcements on stock market returns using Forward Rate Agreements (FRAs).This paper looks at the Johannesburg Stock Exchange (JSE) All Share Index and two other sectoral specific stock market indices (Financial and Industrial sector indices) and assess the responsiveness of these stock market returns to unanticipated monetary policy announcement shock. In an attempt to understand this relationship between monetary policy and the stock market, the main empirical view suggests that decomposing monetary policy changes into anticipated and unanticipated components is crucial for discerning their effects. The decomposition of unexpected policy rates is based on the futures market. In the absence of the South African interest rate futures market, this study employs a FRA which serves as a measure of monetary policy surprise. This study begins with a 1-dayevent study, which examines the immediate impact of monetary policy shocks on the stock market, and then use an Ordinary Least Squares (OLS) regression analysis, which provides insight to into the dynamic effects of the unanticipated interest rate shock on the stock market. This study employs a time series percentage change daily closing prices of the South African stock market (JSE all share Index, sub-indices), actual changes in the South African Reserve Bank (SARB) repo rate, and the FRA, spanning the period January 2010 through to December 2019, which explores the post-global recession dynamics. The study shows that a hypothetical unanticipated increase of 1% repo rate results in a decline of 0.32 percentage of the Johannesburg Stock Exchange ALL SHARE Index. The findings and recommendations are crucial for the South African central bank authorities and stock market participants as it explains the process through which monetary policy outcomes are transmitted to the real economy, inflation and employment. A future piece of work could contemporarily assess the impact of monetary policy and other sector related and political events on the stock market