May MPC Preview - Take It Easy...

The fifth Monetary Policy Committee (MPC) meeting of 2013 will be held on Thursday, May 16. Following Bank of Japan’s (BOJ) unprecedented quantitative easing decision dated April 4, many central banks -- including the ECB -- followed suit, easing their monetary stance further. As expected, this prompted a re-acceleration of capital inflows (cumulative inflows via different channels reached US$10.6bn), validating the CBT’s bid to safeguard financial stability. Moreover, the benign CPI reading of April and disappointing March IP data, indicating still below-potential growth, have strengthened the case for lower rates. Therefore, the CBT is likely to reiterate at the upcoming MPC meeting once again the ingredients of its optimal policy recipe; i.e. accommodating the global low interest rate environment, while increasing foreign currency reserves via macroprudential measures. 

The current monetary stance implies, in our view, that the CBT leaves the door wide open for more rate cuts. Thus, we think a 25bp cut to the policy rate and a 50bp cut to the interest rate corridor seem in the cards for this meeting. On the other hand, in a bid to intensify the sterilisation of capital inflows, a gradual rise in FX and gold ROCs should also be expected. According to the Reuters survey held ahead of the MPC meeting, consensus expectations are skewed towards a 50bp cut for all rates. Out of the 11 economists canvassed, 8 are expecting a 50bp cut to the interest rate corridor this month, while 7 are in anticipation of a 50bp cut to the policy rate, accompanied by a further increase in ROCs and no change in RRs.

Meanwhile, the consistency of the evolution of intermediate variables (loan growth, REER and inflation expectations) of monetary policy with targets (price & financial stability) should remain paramount in the decision-making process. In this framework, at the last Inflation Report, the CBT said “…bringing inflation close to the target without deterioration in external balance requires that credit should be growing at a reasonable rate, while domestic currency should not be appreciating excessively.” However, the CBT does not sound perturbed about above-reference loan growth; rather, it seems the monetary authority continues to overlook the recent strength in loan growth, at least until GDP growth reaches its potential. On the other hand, in response to questions on the real effective exchange rate (REER), Governor Basci stated that the REER was above the 120 threshold during the April MPC meeting, and their decisions at the next meeting would hinge on where the REER lay by then. Indeed, the REER rose to 121.1 in April, from 120.3 in March, according to data released by the CBT. Note that the CBT had already reacted to the above-threshold reading by cutting both the policy rate and the interest rate corridor by 50bp at the April MPC meeting.

However, the TRL has hardly responded to the CBT’s move since then, and continues to trade at around 2.07 against the currency basket (0.5$+0.5€). If the TRL remains below 2.09 levels through the remainder of the month, the REER is likely to overshoot the 120 mark in May as well.

It is also worth noting that following the BOJ’s move, another wave of policy rate cuts by emerging market (EM) central banks has ensued. The average policy rate of selected EM countries -- that is closely monitored by the CBT as well -- has dipped below 4.5% recently. The CBT may seize this opportunity once again to eliminate the prevailing difference in interest rates.

Last but not least, the CBT recently abandoned its active liquidity management policy and stepped up liquidity provision. Consequently, short-term repo and swap rates fell sharply and converged to the borrowing rate. Liquidity provision in excess of the banking system’s needs reinforce our belief that the CBT is contemplating also a borrowing rate cut in order to avert hot money inflows. However, TRL RR need has increased visibly since last Friday. This might suggest that the banks had already lowered their ROM utilisation for certain tranches of ROC; thus, their TRL need increased proportionally. This also may explain the increase in S/T swap rates to more normal levels since Friday. All of these developments possibly imply that the CBT may consider keeping ROC unchanged and become less aggressive on rate decisions, which appears consistent with our call for a 25bp cut to the policy rate.