Setting UK interest rates was once the Chancellor's responsibility. The system was subject to abuse. Chancellors periodically overruled the advice of Treasury experts, especially when an election approached.
Inconsistent economic management helps to explain the quick spurts and even quicker reversals that characterised the UK economy in the past half-century.
For this reason, Labour's May 1997 election victory provided an important benefit to the UK economy. One of the Chancellor's first actions was to de-politicise the rate-setting process. Responsibilities for setting interest rates were assigned to the Monetary Policy Committee (MPC) of the Bank of England. His decision was hugely popular and long overdue.
The MPC has operated in an extremely able and transparent manner during the last eight years. For example, it announces each decision to change rates or keep them unchanged precisely at 12:00 noon on the day each meeting ends. Gone are the days when sudden and unexpected rate announcements would spook investors.
The organisation attempts to fully explain its views to the public. MPC members frequently give speeches outlining their views. Meeting minutes, including the voting record of each voting member, are made available soon after each meeting. Post-meeting press conferences are the norm, not the exception.
Compared to other government rate-setting agencies in Washington and Brussels, the MPC is a model of openness.
Some investors believe MPC openness and accessibility provides short-term traders with an opportunity to make a quick profit in the hours surrounding each monthly announcement. According to theory, knowing what the MPC is likely to announce provides a short-term trading edge.
Is there any validity to this theory? Does MPC transparency provide short-term traders with any profit windows in the hours surrounding each monthly announcement?
A systematic analysis of all price swings surrounding each meeting since June 1997 finds some truth to the theory. Short-term trading opportunities occasionally appear. But they are few and far between. Here is the evidence. See for yourself.
Up-Cycles
There were 98 monthly MPC meetings since June 1997. Sixty-six took place during an interest rate up-cycle. An up-cycle is defined as a period with rising interest rates even though some monthly meetings trigger a no-change announcement.
On the day before each announcement, the UK stock market rose just 22 times and fell 44 times. Fears about the possibility of a rate rise were clearly a concern for nervous investors.
There were no advanced leaks for any specific announcement of course. Even so, anyone who systematically made a short-term bet during the past eight years that shares would decline the day before an announcement would have profited two-thirds of the time.
It is possible to sharpen these profit odds by monitoring price swings in the prior two trading days (day three and day two before an announcement). There were 40 occasions when shares shifted during these two trading days within a range of -0.3 per cent to +2.1 per cent. The odds of a price rise on the following day was just 50:50.
But bigger gains or declines on the prior two trading days were very typically followed by a decline on the day before an announcement. There were 26 shifts of sufficient magnitude in the last eight years during interest rate up-cycles. Prices fell the day before the announcement in 24 of those years.
On the morning of Announcement Day, the profit odds were 50:50 from the opening bell at 8:00am until 12 noon when the announcement is released to the media. But a small window of opportunity occasionally opens.
There were 13 occasions when shares rose on the previous trading day by +0.22 per cent or more. Prices fell 11 times in morning trading hours on Announcement Day and rose just twice. No guarantees of course but the odds heavily favour a morning dip following a solid gain on the previous day.
The period following the noon announcement often disappoints short-term traders. Many assume a rate rise is likely to trigger an immediate stock market drop. By the same token, a no-change decision is widely thought to trigger a relief rally. Both assumptions are wrong. The odds for a price rise in afternoon trading hours are 50:50 no matter if rates are raised or if the MPC decides to leave rates unchanged.
These statistics help to explain why short-term traders find it so difficult to profit with an Announcement Day afternoon punt.
The likelihood of a stock market rise improves on the day following Announcement Day if the MPC does not raise rates. Shares rose after 34 out of 51 no-change announcements, a 67 per cent success rate.
Down-Cycles
The story is much the same during down-cycles. There were 32 MPC meetings held in the last eight years during down-cycles.
Prices rose slightly over half of the time (18 gains versus 14 drops) on the day before the announcement. More of the same occurred on the morning of the announcement from 8:00 am to 12 noon with 18 gains versus 14 declines. Both figures suggest no real bias in trading action for short-term traders to profitably exploit.
But a definite down-side bias does appear once the noon announcement is made. Prices rose just 10 times versus 22 drops. This tendency to decline is equally likely to occur when rates are cut as well as when a no change decision is reached.
On balance, the historical record supports the theory that systematic trading patterns occasionally occur in the hours surrounding Announcement Day. A few of these windows profit short-termers with interesting profit opportunities. But for the most part, profit windows are too small to allow short-term traders to profit. After factoring in trading costs and buy/sell spreads, playing the market in the period immediately surrounding an interest rate announcement is often nothing more than a mug's game.