T&T to duel inflation at its core - Central bank tightens credit, holds repo rates steady

Published: Wednesday September 3, 2008

Trinidad and Tobago's inflation rate hit 11.9 per cent in July to remain at 14-year highs, and prompting a warning from the central bank, CBTT, that the management of price movements would present "a major challenge" in the months ahead given global commodity prices.

Inflation in June was 11.3 per cent.

"There is also a strong likelihood that the inclement weather and recent floods could curtail the supply of agricultural produce and place upward pressure on the prices of many staple agricultural commodities," the CBTT said in a statement.

The bank, headed by Governor Ewart Williams, says its policy actions would focus on dampening credit expansion and containing inflationary pressures.

Outside factors

The extent of tightening will depend on a number of factors, including global food and energy price developments, wage and salary adjustments and fiscal management.

"Reducing the level of liquidity is paramount in the central bank's fight against inflation," said brokerage house Caribbean Money Market Brokers (CMMB).

But: "The central bank is helpless as long as the liquidity injected into the system by the government outweighs that which it can legitimately absorb through tighter monetary policy," said the brokerage.

Food inflation continued to trend upwards rising by 25.3 per cent on a year-on-year basis in July from 23.1 per cent in the previous month.

Core inflation, which filters out the impact of food prices, edged slightly downwards to 6.2 per cent, from 6.4 per cent in June, or as much as three times the levels recorded three years ago, when the rates ranged between to and three per cent over the period 2003 to 2005.

Rapid bank credit expansion

"This surge in core inflation is related to the sharp increase in economic growth which has taken place against the background of declining spare capacity, growing fiscal pressures and booming private demand supported by rapid bank credit expansion," the central bank said.

CBTT has decided to maintain the repo rates at 8.50 per cent but will keep economic and monetary conditions under close review.

CMMB forecasts that inflation in Trinidad and Tobago has not yet peaked and will likely end at 13-15 per cent this year.

The brokerage points to the government's rapid pace of expenditure and the net fiscal injections adding liquidity to the domestic financial system as the basis of its projection.

"This will, as we have seen thus far, fuel domestic aggregate demand, and will be the key source of inflationary pressures going forward. High food prices on the international market will also continue to feed into headline inflation locally and adding to the inflationary pressures on food will be the impact of more flooding and inclement weather on locally produced food. These factors will cause food inflation to hover around 20-25 per cent in the short to medium term," said CMMB.

It noted that the 50 bps hike in the repo rate, as well as the 200 bps increase in the reserve requirement for commercial banks for the year so far, has already resulted in a 100 bps increase in the prime lending rate and a mere 11 bps increase in commercial banks' ordinary savings deposit rate.

Nullified by fiscal policy

While the intent of this action by the central bank was to discourage consumption and curb the expansion in credit, said CMMB, it ended up producing an 89 bps increase in the spread in income accruing to commercial banks.

"Monetary policy appears ineffective in a situation such as the one prevailing now, as the impact of expansionary fiscal policy is completely nullifying the impact of tighter monetary policies, exacerbated by an unfavourable external environment," the brokerage house said.

Shifting interest rates

Given the expected trend, together with the gradual tightening in liquidity, interest rates are also expected to shift upwards, by about 50-100 bps, CMMB estimates.

Currently, the 90-day treasury bill is yielding around 7.17 per cent, and the 180-day, 7.39 per cent.

The central bank this year, in a bid to contain the increase in inflation, raised the cash reserve requirement of commercial banks from 11 per cent to 15 per cent and increased the policy interest rate by 50 basis points.

In addition to its open market operations, some TT$1.2 billion (US$196 million) of government bonds, targeted specifically at liquidity absorption, were issued.

The bank said while it is too early to fully gauge the impact of these measures, recent data from the financial system indicate that in the 12 months to June, private sector credit by the consolidated financial system slowed to 13.3 per cent from around 18 per cent in March.

Consumer credit, which had been growing at a steady clip of around 20 per cent year-on-year in the first five months of 2008, slowed to 16.4 per cent in June.

Credit to businesses also contracted sharply.


Source:
Linda Hutchinson-Jafar
Jamaica Gleaner
http://www.jamaica-gleaner.com/gleaner/20080903/business/business4.html