The effect of interest rate changes on bank stock returns

This study examines the effect of publicly announced changes in official interest rates on the stock returns of the major banks in Australia during the period from 1990 to 2005. Previous studies of such effects have reported inconclusive and mixed results. US evidence suggests that banking stocks are generally negatively (positively) impacted by increases (decreases) in official interest rates. We find, somewhat unexpectedly, that Australian bank stock returns are not negatively impacted by the announced increases in official interest rates. Furthermore, banks apparently experience net-positive abnormal returns when cash rates are increased, which is consistent with dividend valuation theory that suggests if income effects dominate, then stock returns need not be negatively impacted. We explain our findings by the fact that Australian banks, which operate in a less competitive and concentrated banking environment compared to the US, are able to advantageously manage earnings impacts when cash rate changes are announced.