A rate cut of 150 basis points will create a shock. The market is expecting a rate cut equivalent to 100 basis points. If the Central Bank decides to cut the rate by 150 basis points, it will be significantly different from what the market is expecting. This difference between the expected and actual rate cut will act as a shock to the market. The term shock in this context refers to an unexpected event that disrupts the market. It is important to note that the level of a factor often does not matter as much as a shock to the factor. In this case, the shock arises from the difference between the market’s expectation and the actual rate cut. This shock can have various effects on the market, including increased volatility and changes in asset prices.

Choice A is incorrect. A rate cut of 105 basis points will not create a shock in the market as it is very close to the anticipated reduction of 100 basis points. The market has already factored in this change and hence, it would not lead to any significant changes or shocks.

Choice B is incorrect. Similarly, a rate cut of 95 basis points will also not create a shock as it falls within the range of expected reduction. Although it’s slightly less than what was anticipated, the difference isn’t substantial enough to cause any major disruptions in the market.

Choice C is incorrect. A rate cut of exactly 100 basis points won’t create a shock either because this is precisely what the market has been anticipating. Therefore, such an eventuality has already been priced into current valuations and won’t result in any unexpected outcomes.

Things to Remember

• Market Expectations: Market expectations play a crucial role in determining the impact of policy decisions on the market. Any deviation from these expectations can lead to shocks.
• Monetary Policy: Rate cuts are a common tool used by central banks to stimulate economic activity by reducing borrowing costs for businesses and consumers.