Evaluating the impact of central bank communications on exchange rates: the case of Sri Lanka

Abstract

There is a growing interest in how central bank communications may influence exchange rates in emerging market contexts. This paper examines how central bank communications affect exchange rates by conducting a sentiment analysis of press releases from the Central Bank of Sri Lanka (CBSL) and relating these sentiment scores to the LKR-USD exchange rate. The period analyzed spans from October 2012 to December 2024. The sentiment scores were calculated using a dictionary-based approach to analyze monetary policy reviews, inflation, and external sector-related press releases. The relationship between these scores and exchange rates was examined using both daily and monthly exchange rates, while also considering other macroeconomic variables. The results show that the sentiment scores of Monetary Policy press releases have significant positive effect on the daily exchange rate fluctuations at 5% level. In monthly exchange rate model, the average monetary policy sentiment also has a positive effect, which is significant at the 10% level, whereas sentiment of the external sector press releases has a marginally negative effect, which is significant at the 10% level. This study provides initial empirical support for the notion that the language used by the central bank has the potential to predict the direction of exchange rate movements in Sri Lanka, indicating how central bank language can influence market expectations.