Measuring Interest Rate Expectations in Canada

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Financial market expectations regarding future policy actions by the Bank of Canada are an important input into the Bank's decision-making process, and they can be measured using a variety of sources. The author develops a simple expectations-based model to focus on measuring interest rate expectations that are implied by the current level of money market yields. The explanatory power of this model increases markedly in the period following the implementation of the Bank's regime of fixed announcement dates in November 2000, and it appears to accurately describe the behaviour of short-term yields. Term premiums are estimated for the various instruments examined, and observed market yields are adjusted by those amounts. Once the market yields are adjusted, they can be used to calculate implied forward rates for a series of dates in the future. These forward rates can be interpreted as representing the market's expectations for the future level of overnight rates at a specific date.

JEL Code(s): G, G1