Policy rate
The short-term interest rate a central bank sets or targets to conduct monetary policy. It anchors the short end of the yield curve, so markets price in its expected path.
Where you will meet it
Policy rate appears in 10 learning outcomes on the CFA syllabus. A few of them:
- Set out the instruments available for monetary policy
“The policy rate is the central instrument, influencing short-term market rates and from there borrowing costs across the economy.”
- Explain the short-term rate spreads that serve as gauges of credit and liquidity risk across the economy
“The classic measures were built on Libor, which has been discontinued: the TED spread, three-month Libor minus the three-month Treasury bill yield, and the Libor–OIS spread, which strips out expected policy rates because the overnight indexed swap rate tracks the expected overnight rate.”
- Explain why an economic factor can move market values only by acting on at least one of three channels: default-free rates at each maturity, how large and how soon expected cash flows are, and risk premiums
“A surprise rise in unemployment may cut expected profits, lower policy rates and raise risk aversion at once.”
- Explain why equity and fixed income investors care about potential GDP and how fast it grows
“For bond investors, the gap between actual and potential output signals inflation pressure: growth above potential opens a positive output gap, pushing inflation and policy rates up and bond prices down.”
See also
Practise it
Practise policy rate until it is automatic: questions that explain every wrong option.
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