Analysis: Stock Market Movements and UK Monetary Policy

This report investigates the intricate relationship between stock market movements and monetary policy in the United Kingdom. The analysis utilizes data related to the FTSE index, inflation rates, and LIBOR rates to understand their interdependencies. The report employs both theoretical concepts and empirical analysis, including correlation techniques, to identify how changes in the stock market influence the decisions of the UK's central bank. Monthly data from the UK is evaluated to determine the connection between stock market fluctuations and monetary policy adjustments. The findings suggest a positive correlation between stock market performance and monetary policy responses, where the central bank adjusts interest rates in response to market volatility. The report concludes with recommendations based on the findings, offering insights into managing financial stability and investor confidence in the UK economy. The study covers an analysis of the data for the months of May to February.

The effect of stock markets
movements in monetary policy for
UK

ABSTRACT
This report is prepared on stock market movements and its impact on the monetary
policy of the nation. In order to understand relationship between both data related to inflation
rate, FTSE and LIBOR are taken in account. Up and down in their values are related to each
other. For this, theoretical concepts are used related to stock market and monetary policy.
Further, various books and journals are reviewed. Correlation technique is also applied on data
set and it is found out that there is positive relationship between stock market movement and
monetary policy. In the report, data related to each and every month is evaluated and relationship
between stock market movement and monetary policy is identified. At end of the report,
conclusion is prepared and recommendations are made and in this way project is completed.

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................4
Methodology ...................................................................................................................................4
Analysis and findings.......................................................................................................................5
Analysis of values of variables on 31st May..............................................................................6
Analysis of values of variables on 30th June..............................................................................6
Analysis of values of variables on 31st July...............................................................................7
Analysis of values of variables on 31st August..........................................................................7
Analysis of values of variables on 30th September....................................................................8
Analysis of values of variables on 31st October.........................................................................9
Analysis of values of variables on 30th November..................................................................10
Analysis of values of variables on 31st December..................................................................10
Analysis of values of variables on 31st January......................................................................11
Analysis of values of variables on 28th February.....................................................................11
CONCLUSION AND RECOMENDATION................................................................................12
REFRENCES ...............................................................................................................................13
INDEX OF TABLES
Table 1: Correlation of FTSE with monetary policy.......................................................................6
Table 2: Values of variable of 31st May..........................................................................................7
Table 3: Values of variable of 31st June .........................................................................................7
Table 4: Values of variables on 31st July........................................................................................8
Table 5: Values of variables on 31st August...................................................................................8
Table 6: values of variables on 30th September..............................................................................9
Table 7: values of variables on 31st October.................................................................................10
Table 8: values of variables on 30th November............................................................................11
Table 9: values of variables on 31st December.............................................................................11
Table 10: values of variables on 31st January...............................................................................12
Table 11: values of variables on 28th February.............................................................................12

INTRODUCTION
Stock market is very volatile and its movement indicates the ups and down in the nation
economy. In stock market, domestic and foreign investors both make investment and when they
makes heavy sale of shares in the market it badly affects economy and its currency value. In such
situations, central bank comes forward and takes some of the steps which increases the nation
growth rate and control inflation rate which brings price stability (Monetary policy committee,
2016). This is the reason due to which stock market movement greatly affects monetary policy of
the nation. In this research study, to understand relationship between stock market movement
and its impact on monetary policy of the firm data of inflation rate, FTSE values and central
bank LIBID/LIBOR rate are taken into consideration. Relationship between this data set is
identified in the present study. It has been seen that stock market return or percentage change in
index value directly reflects investor’s sentiments. This indicates the perception which the
investors prepare about the likely changes that can be observed in the economy in upcoming
years. If fear factor reach to certain level among the investors they start selling shares and heavy
amount of cash outflow takes place in an economy. It is monetary policy as by using this central
bank can bring changes in its monetary policy components. By making changes in these
components, either cash flow is increased or decreased in an economy. If cash flow increases
above certain level then money supply increased in the economy and inflation rate rose. This
leads to occurrence of negative sentiments among the investors. Thus, in order to prevent decline
in stock market or to bring in bullish mode, central bank changes monetary policy and tries to
build confidence among the investors (Justiniano, Primiceri. and Tambalotti, 2011). Hence, it
can be said that stock market to great extent affects monetary policy of the government. It can be
observed in the practical world that with every big change in stock market, central banks conduct
a meeting at the end of the month to discuss economic issues. In the meeting, decisions related to
increase or decrease in interest rate is taken by the firm.
METHODOLOGY
While conducting a research, its methodology is determined by the researcher and by
doing this it determine the best way in which research can be conducted in a better way. There
are two types of techniques for data analysis which are qualitative and quantitative methods
(Gertler. and Karadi, 2011). In qualitative method of analysis figures are analyzed by using
statistical tools like mean, median and mode etc. whereas, in qualitative method research is done

by just theoretically correlating figures with each other. In order to conduct this study in perfect
way, both qualitative and quantitative methods are used. Correlation as a statistical tool is
applied on data set of all variables. By using this quantitative technique of data analysis, it is
identified that stock market movements greatly affects monetary policy of the nation. By using
this statistical tool relationship between inflation rate and central banks interest rates is identified
by the managers. Along with this, qualitative approach of data analysis is also used in the
research and all figures are correlated with each other theoretically (Blanchard, Dell’Ariccia. and
Mauro, 2010). In this, it is identified that what sort of changes comes in interest rates of central
bank after increase or decrease in index value of FTSE. On the basis of this, it is identified that
stock market movements are greatly affecting monetary policy of the UK central bank. Thus, it
can be said that both type of evaluation methods helps in deriving valuable conclusions about the
relationship between stock market movement and monetary policy. In order to conduct data
analysis facts related to the UK inflation rate, LIBOR rates and index value figures were
collected. On the basis of index value table, percentage changes table of index of London stock
exchange was prepared (Kurov, 2010). Thereafter, by using correlation which is a statistical tool
relationship between stock market movement and interest rate which is proxy of central bank
monetary policy is identified. By using correlation method relationship between inflation rate
and interest rates is also identified. Hence, in this way by using this, appropriate research
methodology research is conducted in a proper way by the researcher.
ANALYSIS AND FINDINGS
Table 1: Correlation of FTSE with monetary policy
FTSE Inflation rate
31 May 0.34% 0.1% 0.54
30 Jun -6.63% 0.0% 0.551
31 Jul 2.68% 0.1% 0.567
31 Aug -6.71% 0.1% 0.57
30 Sep -2.98% -0.1% 0.57
31 Oct 4.95% -0.1% 0.57
30 Nov -0.08% 0.2% 0.57
31 Dec -1.79% 0.2% 0.57

31 Jan -2.55% 0.2% 0.566
29 Feb 0.23% 0.3% 0.565
Correlation of FTSE with
monetary policy 0.12
Correlation of inflation rate with
monetary policy 0.04
In order to analyze stock market movement and its impact on monetary policy of UK
each month data will be analyzed differently.
Analysis of values of variables on 31st May
Table 2: Values of variable of 31st May
FTSE Inflation rate LIBOR rate
31 May 0.34% 0.1% 0.54
On analysis of data it can be seen that FTSE value increased by only 0.34% which means
that index rose by just 24 points. LIBOR rate is 0.54 and inflation is 0.1%. This is the first table
and there is no other table to compare and due to this reason it is very difficult to identify the
impact of stock market movement on monetary policy of the central bank. From figures it can be
seen that FTSE index value plunged by small percentage and its can be said that performance of
index cannot be considered good or bad. If we look at the further month inflation rate then it can
be observed that in the month of May there was one of lowest inflation rate of 2015 (Bekaert,
Hoerova. and Duca, 2013). This not only happens in the case of inflation rate but in LIBOR rate
same thing is observed. This reflects that inflation rate was low and due to this reason LIBOR
rate was also kept low by the central bank. This indicates that at time it was perception of central
bank that inflation is in control.
Analysis of values of variables on 30th June
Table 3: Values of variable of 31st June
FTSE Inflation rate LIBOR rate
31 May 0.34% 0.1% 0.540
30 Jun -6.63% 0.0% 0.551

Interpretation
On evaluating the figures it can be seen that LIBOR rate was increased in UK in the
month of June relative to month of May. In the month of June, FTSE index value fall by -6.63%
and it indicate that market give poor performance. Investors in UK evaluate economy by looking
at the nation inflation rate. If the market decline, then possibility of elevation in interest rate was
the matter of concern for the central bank. There was possibility that if inflation rate get
increased then negative sentiments may be originated among investors and pressure can be
observed in the equity market. Hence, in order to further prevent decline in stock market, central
bank increases interest rate by some basis points (Rey, 2015). Due to this reason, liquidity and
purchasing power of people get reduced. Due to decline in demand inflation rate, it will also fall
and prices will be stable in the economy which will give message to investors that economy of
UK is stable. If investors believe that, UK economy is stable then investment will increase in the
UK. Hence, central bank increases its LIBOR rate to control inflation rate in response to sharp
decline in FTSE value in the month of June.
Analysis of values of variables on 31st July
Table 4: Values of variables on 31st July
FTSE Inflation rate LIBOR rate
30 Jun -6.63% 0.0% 0.551
31 Jul 2.68% 0.1% 0.567
Interpretation
It can be seen from the above table that in the month of July, FTSE index value increased
by 2.68% which means that relative to previous month index value rose by 174 points. This was
magnificent plunge in index value after steep decline in figure of the same. Central bank in this
month sharply elevates LIBOR rate even FTSE value increases. This was done to maintain
control over inflation rate in the UK. Inflation rate already reached to the 0.0% which can be
assumed as non inflation and deflation level in the economy. Central bank wants to maintain
inflation rate at this level to maintain stability in price of goods and to build confidence among
the investors about the growth of the UK economy (Calza, Monacelli. and Stracca, 2013).
Central bank wants to make sure that stock market will give positive results in next month also
and by controlling inflation rate as it wants to show that price stability comes in the UK market

and it is safe investment avenue for the investors. Hence, in order to continue positive movement
in FTSE in next month also central bank increases its LIBOR rate.
Analysis of values of variables on 31st August
Table 5: Values of variables on 31st August
FTSE Inflation rate LIBOR rate
31 Jul 2.68% 0.1% 0.567
31 Aug -6.71% 0.1% 0.570
Interpretation
Even central bank hike its LIBOR rate then also its inflation rate increased from 0.0% to
0.1% in the UK economy. This was one of the negative factor due to which investors sell their
shares in the stock market and FTSE decline by -6.71% which means that index fall by 450
points in a month. This was sharp decline in the UK market and investors lost big amount on
their shares. Again central bank to maintain control on inflation rate and to make investors
believe that UK economy is on growth track and situation is in control, it enhanced LIBOR rate
to 0.570 by 3 basis points. It gets success in same and in the month of August inflation rate
remained unchanged relative to July month. This was sharp decline in the index value which
forced central bank to elevate interest rate by 3 basis points even inflation rate remain same
(Wright, 2012). This proves that stock market movements greatly affect movement in index
value. It has been seen that investors wait for the central bank monetary policy because changes
in interest rate whether it is positive or negative reflects the direction in which nation economy is
going.
Analysis of values of variables on 30th September
Table 6: values of variables on 30th September
FTSE Inflation rate LIBOR rate
31 Aug -6.71% 0.1% 0.570
30 Sep -2.98% -0.1% 0.570
Interpretation
FTSE fall in the month of September consistently after steep decline was observed in the
month of August. Even after fall in value of FTSE, no change was observed in the LIBOR rate

and it remained at the level of 0.570. This happened because central bank already made big
elevation in its interest rates from the month of March to September from 0.540 to 0.570
approximately by 20 basis points. Central bank think that if it will increase LIBOR rate then
deflation may comes in existence in the economy because inflation rate was already 0.1% which
is nearby to 0.0% which is state of no inflation and no deflation. However, rates kept unchanged,
inflation rate become negative which was not good for economy (Filis, Degiannakis. and Floros.,
2011). It was fear factor of further decline in the index value which compel central bank to keep
interest rate unchanged. This proved that stock market movement affects monetary policy of the
central bank. The other main reason that was responsible for no change in LIBOR rate was that
there was vagueness about the international conditions. While preparing a monetary policy not
only stock market condition is considered but changes in international economy are also taken
into account. When there is vagueness about changes that may happen in the international market
it is very difficult for the central bank to bring changes in its monetary policy. Thus, this may be
one of the main reasons responsible for stability in the LIBOR rate in the UK in the month of
September.
Analysis of values of variables on 31st October
Table 7: values of variables on 31st October
FTSE Inflation rate LIBOR rate
30 Sep -2.98% -0.1% 0.570
31 Oct 4.95% -0.1% 0.570
Interpretation
In the month of October FTSE value increased by 4.95% which means that index value
increased by 300 points which was very high positive jump in the figure of mentioned index. In
response to sudden positive change in the index value, LIBOR rate remain unchanged. This
happens because if stock market movement is analyzed then it was unprecedented change in the
index value. In the month of August, index value declined by -6.71% and then in the month of
September its value again declined to -2.98% which means that in these two months index fall by
635 points. In the month of October, FTSE recover and increased by 300 points. This pattern of
movement in value of variable way does not indicate the direction in which stock market may go
in the next month (Claessens. and et.al., 2010). There was high uncertainty about global

economic conditions and response of domestic stock market to these conditions. Hence, no
changes were made in the LIBOR interest rates even inflation rate was negative. Negative
inflation rate send a negative message to the investors and it was the symbol of slowdown in
demand from people side. If in this situation as per trend in LIBOR rates if central bank would
elevate rates then it will negatively affect demand from people side. It will also generate negative
sentiments among the investors and sale pressure could be observed in the next month. Hence,
according to stock market movement, central bank keeps its interest rates unchanged.
Analysis of values of variables on 30th November
Table 8: values of variables on 30th November
FTSE Inflation rate LIBOR rate
31 Oct 4.95% -0.1% 0.570
30 Nov -0.08% 0.2% 0.570
Interpretation
As said above, there was vagueness about the changes that may takes place in the stock
market index value fall by -0.08% merely by 5 points. This was small decline in the index value
but it reflects that heavy fluctuation was observed in the month of November. In response to
slight change in FTSE value no change was made in the monetary policy because at the same
rate market earlier gave positive return to the shareholders (Narayan. and Narayan, 2010).
Central bank does not want to make inflation rate negative and due to this reason also it does not
make any change in its monetary policy. In this month, inflation rate increased to 0.2% from -
0.1% and it can be said that it was sudden change in the inflation rate of the UK. In response to
this FTSE, value decline by small percentage. In response to such a change in inflation rate no
big response came from investor side and FTSE fall only by -0.08%. Hence, central bank does
not make any change in its monetary policy and keep LIBOR rate same at 0.570.
Analysis of values of variables on 31st December
Table 9: values of variables on 31st December
FTSE Inflation rate LIBOR rate
30 Nov -0.08% 0.2% 0.570
31 Dec -1.79% 0.2% 0.570

Interpretation
In this month, consistently index value decline and the only difference is that in the
month of November FTSE fall slightly but in the month of December return of FTSE declined to
-1.79%. This means that in the month of December index value declined by 114 points. Even
market declined sharply and no change was observed in the LIBOR rate. This was strange that
market fall by higher percentage but no change was made in the LIBOR rate (Gambacorta,
Hofmann. and Peersman, 2014). Inflation rate also remain same in this month also and elevate
from 0.0% to 0.2% but no action was taken by the central bank. On evaluating the figures no
specific reason is identified which may be responsible for stable LIBOR rate. There may be one
reason that central bank think that this decline in stock market is mainly driven by external
factors and domestic factors are minor responsible for decline in index value. This estimation
may be correct because in this month China was going to release its industry production data. It
was believed that poor performance will be observed in the Chinese economy. Hence, there was
turmoil among the investors and decline was observed in the index of major Asian, Europe and
USA markets. Hence, it is obvious that in such a situation it is not possible for FTSE to grow.
Central bank knows that even it bring changes in its monetary policy then also it cannot prevent
decline in stock market. Hence, it keep its LIBOR rate same and wait for positive change in the
stock market.
Analysis of values of variables on 31st January
Table 10: values of variables on 31st January
FTSE Inflation rate LIBOR rate
31 Dec -1.79% 0.2% 0.570
31 Jan -2.55% 0.2% 0.566
Interpretation
In the month of January again, decline in index value was observed and value of LIBOR
declined. In response to change in stock market condition, central bank brought changes in its
interest rate (Choi. and Hammoudeh, 2010). Due to stability in inflation rate at 0.2% heavy
decline was observed and in response to this central bank reduced its inflation rate. Hence, it can
be said that stock market movements affects monetary policy of the central bank.

Analysis of values of variables on 28th February
Table 11: values of variables on 28th February
FTSE Inflation rate LIBOR rate
31 Jan -2.55% 0.2% 0.566
29 Feb 0.23% 0.3% 0.565
Interpretation
In February month, positive change was observed in the FTSE value and decline was
witnessed in the interest rate. In order to keep these trend continue it was necessary to reduce
LIBOR rates (Borio. and Zhu, 2012). So that investors think that central bank along with
focusing on inflation rate is also giving emphasis on promoting investment in industries that are
established on its land. Thus, in response to change in stock market LIBOR rate was further
changed by the central bank.
CONCLUSION AND RECOMENDATION
On the basis of above discussion and positive values of correlation it is concluded that
with change in stock market, changes are made in the monetary policy of the nation. This is done
to maintain confidence among the investors that every measure is taken to bring nation on
growth track. It is recommended that central banks must not only focus on single factor like
inflation while preparing monetary policy. They must also try to promote investment in the
nation along with focusing on inflation rate.