- Commits to intervene to stabilize yields in the future as they have “overshot”
- CB rejects bids above last week’s levels at this week’s Treasury bill auction
- Recognizes that no rate hike could address current inflationary pressures
The Central Bank left key rates unchanged yesterday while sending a clear signal to markets that yields have peaked, and signaled it would intervene going forward to stabilize government bond yields at lower levels.
Leaving the permanent deposit and permanent lending facility rates at 13.50% and 14.50% respectively, the Central Bank said market lending rates were rapidly adjusting upwards, and added that no Further rate increases would only solve the current inflation, which is mainly supply-driven. side issues and lingering effects of the failed rupee float.
In a precursor to yesterday’s monetary policy announcement, the Central Bank rejected all offers above the levels received the previous week and accepted only a fraction of the total amount offered, indicating that it would not will not accept higher returns.
The Central Bank offered 90 billion rupees in treasury bills at the auction held on Wednesday, but only accepted 16.5 billion rupees received at yields matching the previous week’s levels of 24.07% , 24.69% and 24.50% for 3, 6 and 12- month tenors respectively.
“The yield curve has shifted more than expected and that is why we think we need to stabilize interest rates, and so we will intervene,” Central Bank Governor Dr Nandalal Weerasinghe said. adding that they would continue to do so until the returns begin. relaxation.
Data showed the benchmark weekly average prime rate rose 13.60% and the yield on benchmark 1-year bills climbed 19.25% since the Central Bank turned hawkish from August. 2021 in response to a cumulative 9.0% increase in policy rates through April 2022.
Dr Weeraisnghe called this excessive and called it an “overshoot”, which needs to be stabilized through interventions through their weekly bill auctions and open market operations where they could inject liquidity.
Dr. Weerasinghe’s comments reflect that certain interventions are warranted to restore common sense when free markets generate undesirable and unintended results.
In its most hawkish pivot ever, the Central Bank shocked markets by raising its benchmark rates by an unprecedented 700 basis points in April to destroy demand in a bid to reduce imports and thus pressure on the balance of payments deficit, while controlling inflation.
This was done based on his assessment that the rising imports and accelerating inflation were a result of the warmer demand conditions prevailing in the economy at the time.
However, Dr Weerasinghe said the current inflation is “not necessarily” driven by demand but by supply constraints, both inside and outside the country and by some of the adjustments of one-off prices such as energy and food in response to the steeper decline in the rupee.
“We see imports going down; we see credit growth declining; we see monetary policy tightening and exchange rate depreciation ripple through the economy to reduce the demand component of this aggregate demand,” Dr Weerasinghe said.
Central Bank data showed real private sector credit in March actually contracted by 18.0 billion rupees after adjusting for the revaluation impact of the sharp depreciation of the rupee during the month. .
However, there was a sharp change in language from Central Bank officials yesterday since the last monetary policy meeting on the real causes of inflation, apart from the shock impact of the floating the rupee. “Of course, cost and supply issues that we have to deal with separately,” Dr Weerasinghe said.
“I don’t think we should raise interest rates in line with headline inflation in this situation, because we see aggregate demand slowing down in line with our monetary policy actions,” he acknowledged.
He said headline inflation over the next two months could peak north of 40% before starting to subside thereafter as demand-destroying policies take full hold by then.
Under these circumstances, the Central Bank hinted at a potential contraction in the economy, as demand-destroying measures and tighter financial conditions could undermine any prospects for expansion.
Central banks around the world, with the exception of China, are tightening monetary policies, pulling back their two years of pandemic stimulus to fight inflation.