Working Paper Series no. 361: How do anticipated changes to short-term market rates influence banks' retail interest rates? Evidence from the four major euro area economies

Abstract

In this paper we argue that banks anticipate short-term market rates when setting interest rates on loans and deposits. In order to include anticipated rates in an empirical model, we use two methods to forecast market rates - a level, slope, curvature model and a principal components model - before including them in a model of retail rate adjustment for four retail rates in four major euro area economies. Using both aggregate data and data from individual French banks, we find a significant role for forecasts of market rates in determining retail rates; alternative specifications with futures information yield comparable results

Anindya Banerjee, Victor Bystrov and Paul Mizen
February 2012

Classification JEL : C32, C53, E43, E44

Keywords : forecasting, factor models, interest rates, pass-through