Market-Based Measures of Monetary Policy Expectations and Their Evolution Since the Introduction of the Euro

The paper considers the relation between monetary policy expectations and financial markets in the case of Europe. A number of money market instruments are compared, with the result that the 1‐month forward interest rates extracted from the Libor yield curve has the best prediction power of the future monetary policy path. These forward rates have been used to study the evolution of market expectations regarding the monetary policy of the European Central Bank (ECB). The sharp increases and the following decreases in interest rates during 2000–2001 have reduced the predictive power of money market instruments, but smoother management of interest rates and better communication from the ECB has helped to improve the forecasting power of money market instruments.