The signal from the Bank of Jamaica (BOJ) that it could increase its benchmark interest rate at the end of this month, as it seeks to contain inflationary pressures, is seen as a wrong move at this time by at least two economists and an investment banker.
Dr Adrian Stokes, Senior Vice-President (SVP) and head of Insurance and Wealth Management at the Scotia Group Jamaica — and a financial economist — outlined that he doesn’t “see the justification for tightening monetary conditions in a depressed economy”, citing that the inflationary headwinds the central bank is scheduling its decision on are temporary.
Dr Andre Haughton, senior lecturer in the Department of Economics at the University of the West Indies (UWI), Mona, shared the sentiments but added, “when you are in an economy like Jamaica and you are in a crisis like this one, you have to think about other objectives other that just satisfying an inflation target”.
Jermaine Burrell, group research manager, JMMB Group, pointed out, “given we are in a weak economy with so many challenges, I would be concerned the central bank is looking to increase the cost of capital”.
The Bank of Jamaica gave the signal that it could increase its policy interest rate for the first time since December 2008 — a period spanning almost 13 years — come the end of September, after the Statistical Institute of Jamaica (Statin) — the Government entity responsible for collecting, collating and disseminating economic data — said consumer prices rose 1.5 per cent in July, their fastest pace of expansion for a single month in seven years. Over the 12 months to July, consumer prices have increased an average 5.3 per cent — a pace of increase that is within the four-six per cent band the BOJ is mandated to keep inflation.
However, the bank said inflation is “likely to breach the upper bound of the…target range over the next year (starting from as early as the September 2021 quarter)”. The projection is for inflation in the next two years to be in the range 5 1/2 – 6 1/2 per cent. On the other hand, the central bank’s policy rate, which has been cut 32 times since June 2009 when it was 17 per cent, has been at 0.5 per cent since August 2019 — a period spanning just over two years. The belief is that the central bank could increase rates by no more than 0.25 per cent this month.
But for Stokes, Haughton and Burrell, the inflation forecast does not suggest projected price increases over the next two years are high enough to push the BOJ at this time to increase interest rates. The BOJ’s mandate, as set out in the Bank of Jamaica (Amendment) Act 2020 which became effective on April 16, 2021, is the maintenance of price stability and financial system stability with price stability being the primary objective.
Stokes, however, noted, “Notwithstanding that single mandate, it seems to me, the MPC [the Monetary Policy Committee, the body which is responsible for setting interest rates at the BOJ] would need to have a far more aggressive forecast of inflation expectations to begin reigning in monetary conditions. If you compare what’s happening in the US where they have a much stronger economy, inflation is running much further ahead of their target and the Federal Reserve there is just beginning to think about tapering, not even to tighten monetary conditions, but to taper the unprecedented level of support it has been given to its economy.”
Inflation in the US at the end of July was running at an annual rate of 5.4 per cent. That rate is well above the two per cent target the Federal Reserve attempts to meet each year. As for tapering, it refers to a the US central bank slowing its intervention in the economy, which it does through buying its government’s bonds and mortgage-backed securities. Each month the Fed has been purchasing US$120 billion worth of assets, effectively increasing the supply of money in the economy by that amount in an effort to help boost economic activity.
“Given where we are in Jamaica,” Stokes continued, “given that the economy is still in a material slump — in fact, the economy is expected to remain below its peak 2019 level, even over the next two years, so there is no justification that I can find, and when you look at the MPC minutes, they themselves say the effects are transitory, so you don’t increase rates or tighten monetary conditions to respond to transitory effects, as a rule of thumb, that’s something you certainly don’t do.”
“Markets trade in the future, which means that when a central bank indicates that it is looking to tighten monetary conditions, what happens is that the market starts to tighten monetary conditions today. In other words, what you should expect to see starting September is for monetary conditions in the banking system to begin to reflect what the central bank has communicated. In other words, financial entities will start to increase interest rates.”
Burrell outlined what such a move will mean for people in the real economy. “When you look at the structure of most loans, they are variable rate loans…so once interest rates start to go up you might find that you have challenges from the perspective of increase mortgage rates on the commercial or retail side. Then when you move to the more institutional side with the larger investors, you find that bank loans that they take out are variable rate loans and these loans will begin to go up. So if you borrow $200 or 300mn…this begins to show up in your [financials affecting profitability] when interest costs begin to go up on the loan, unless the institution negotiated a fixed rate loan.”
He argued that while “some persons might say, but we see where the economy has grown by more than 12 per cent [in the last quarter]…but remember that one of the things we must bear in mind is that we contracted last year, in one quarter by 18 per cent. So a lot of it is just rebound and recovery. And with the [coronavirus] cases going up and with the lockdown, there is not much economic activity….so, depending on a timing perspective, we may see recovery in one quarter but then by the time we start to look at the numbers for the next quarter when there is a lockdown, we see a much weaker number. That’s what we have to bear in mind. So even though we are saying we are seeing a little recovery, we must bear in mind that the overall economic climate is one of a contracting economy and its not only for Jamaica, we have contractions globally, most economies are facing the same thing.” For this year, the PIOJ has forecast the economy will expand in a range from six-10 per cent and pre-COVID-19 gross domestic product will not be attained until two years time.
Haughton contends that raising interest rates to control inflation at a time when the Government is not expanding spending will have a deleterious impact. “Fundamentally, Jamaica’s inflation issue can only be solved by [improving] productivity…fiscal and monetary policy have to work together to influence an improvement in productivity instead of focusing solely on an internal target for inflation, which is not reflecting [what’s happening in] the real economy.”
All three called on the central bank to walk the road of increasing interest rates slowly, adding that the central bank must realise that even though its mandate is to manage inflation, it must realise that it has broader influence on the economy.