ECB’s monetary policy spillovers to financial markets: Evidence from small open economies

Abstract

This thesis investigates the impact of European Central Bank’s (ECB) monetary policy surprise spillovers on the financial markets of Sweden and Denmark, non-euro-area small open economies with close economic and political ties to the euro area. Using high-frequency intra-day interest rate data from 2006 to 2022, with a focus on the effective lower bound (ELB) period, the study reveals significant spillovers.

Path surprises correlate with positive effects on government bond yields, particularly in Denmark. In addition, a path surprise is associated with the euro depreciating against SEK, suggesting a potential portfolio rebalance channel. No evidence is found for target surprises affecting money market rates, indicating domestic central banks' higher control on shorter yields. During the ELB period, surprise spillovers negatively impact Swedish and Danish equity markets, especially the industrial sector.

This thesis contributes to the discourse on the “trilemma” of international economics, proposing a partial “dilemma” for small open economies: incumbent central banks extort a higher control on the shorter end of the yield curve while large central banks affect the longer end. Furthermore, this thesis initiates a discourse on quantifying the potency of monetary policy surprises and introduces a novel indicator that, in its present form, proves beneficial for practitioners in the field of financial economics.