BoE Policy Rate Tied to Market Expectations, Study Finds

The relationship between central banks and government bond yields is complex and nuanced. A recent study by William_Playfair, an indicator on TradingView, suggests that the Bank of England (BoE) policy rate follows the market's expectations for short-term interest rates.

According to Federal Reserve Governor Christopher Waller, the 2-year Treasury yield is a good proxy for the stance of monetary policy. In a 2023 speech, he described how the 2-year Treasury rose from 0.25% in September 2021 to around 2% by the March 2022 FOMC meeting, even though the Fed had not yet begun raising its policy rate.

Waller explained that the causal chain can operate like this: Economic information → expected Fed/BoE reaction → central-bank communication → market repricing → 2-year yield moves → eventual policy decision. This suggests a feedback loop rather than a simple leader/follower relationship between the bond market and the central bank.

The Bank of England has similar evidence in its communications, with MPC member Catherine Mann repeatedly discussing the relationship between market-implied policy curves and expected future paths for short-term rates.