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Only way is up, Only Question is when

Published: 2/04/2010 at 12:00 AM

Newspaper section: Business

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A clear and common perception in the market is that interest rates are on the verge of rising. Indeed, we are now starting to see rising interest rates among term-deposit products offered by commercial banks, as well as higher yields in recently issued corporate bonds, despite the one-day repurchase rate (the Bank of Thailand's policy interest rate under its inflation-targeting framework) remaining at 1.25%.

 

 

Unlike other monetary frameworks of the past like a fixed exchange rate or money growth targeting, the inflation-targeting framework gives the central banker a greater deal of discretion. The explicit core inflation target is announced as a range. When core inflation strays outside the range, action should be taken swiftly. However, when it does not, it by no means implies that no action will be taken.

 

The goal of the central bank's Monetary Policy Committee (MPC) is to anchor the economy's inflation expectation. That means the MPC must be pre-emptive in its action. Due to the impact lag of monetary policy, if the MPC waits until core inflation races past its range, its action will be too late. Therefore, more information beyond core inflation and output gaps must be processed.

 

All signals indicate increased inflationary pressure. Asset prices have increased strongly throughout the region. There is talk in the media of Chinese asset bubbles and its government trying to curve lending. India, Malaysia, Australia and Vietnam have raised their key policy rates this year, in response to looming inflation threats. The SET index has also climbed to its highest level in more than a year, despite the political rallies blocking the streets of Bangkok.

 

The economy has baffled all forecasters by rebounding more strongly than expected since the fourth quarter of 2009. Unemployment has come down below 1%, while capacity utilisation has returned to its pre-crisis level.

 

This brings us to this year's million-dollar questions: When will the MPC raise the policy rate? And by how much? TMB Analytics' take on these questions can be best summarised by the fan-chart projecting the path of the policy rate from 2010 to 2011. Graphically, the chart gives us the probability distribution of forecasts on the basis of our baseline projection weighed by the surrounding relevant risks.

 

Specifically, our baseline is the most probable course of the policy rate and is represented by the darkest line in the middle of the graph. The gradually spreading fan depicts the degree of uncertainty from the baseline. The darker shades highlight greater likelihood of the policy rate to realise certain values.

 

Our fan-chart suggests the policy rate could go up as early as this quarter with the magnitude of increase bounded from 25 to 75 basis points. The MPC is set to meet on April 21 and June 2.

 

Over the medium term, the upward trend of the policy rate will likely continue as the economic recovery gains traction. We also believe potential upside factors will be dominant in the outlook, as seen in the fan-chart skewing upward throughout the end of this year.

 

Relevant to consumers is commercial bank rates such as the minimum lending rate (MLR). We expect the spread between the MLR and the policy rate to narrow, meaning the MLR will not increase as fast as the policy rate. This is not unique to this period. Historically we find asymmetric adjustments of MLR to the cycles of the policy rate. Upward adjustment tends to be slower and prolonged for around six months, while downward adjustment tended to be quick, mostly within one month.

 

With business piping along on the economy front, economic growth will take a backseat as a priority for the MPC. The focus will be taming brewing inflationary pressure, one of the Bank of Thailand's main responsibilities. So how long would it take for the policy rate movement to get passed through to the general price level?

 

Our study points to a period of four quarters after the policy rate hike so as to observe non-negligible slowdown in core inflation, meaning the MPC's decision is forward-looking for about a year.

 

It has been quite some time since the last interest rate adjustment. The policy rate has remained at this historically low level for the past 12 months, while the MLR has been at its current level for the past 10 months.

 

In contrast to 2009 when every figure was plunging, all economic figures are marching upward this year with the exception of interest rates. And soon they too will rise.

 

 

 

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Dr Sutapa Amornvivat is executive vice-president and head of risk analytics and research at TMB Bank. Dr Benjarong Suwankiri is an economist from TMB Bank's Risk Analytics and Research Group. They can be reached at macro@tmbbank.com