CB keeps policy rates steady signalling peak yields in G-Secs

• Vows to intervene to stabilise yields going forward as they have “overshot”      
• CB rejects bids above last week’s levels at this week’s T-bill auctions
• Acknowledges that no amount of rate hikes could address current inflationary pressures

The Central Bank left its key policy rates unchanged yesterday while sending a clear signal to the markets that yields are peaked, and indicated that it would intervene going forward to stabilise the government securities yields at lower levels. 

Leaving Standing Deposit and Standing Lending Facility rates at 13.50 percent and 14.50 percent respectively, the Central Bank said the market lending rates are fast adjusting upwards, and added that no amount of more rates hikes would address the current inflation, which is mostly stoked by supply side issues and lingering effects of the botched rupee float.   

 
In a precursor to the monetary policy announcement yesterday, the Central Bank rejected all bids above the levels received in the previous week, and accepted only a fraction of the total amount offered in an indication that it won’t entertain higher yields.

The Central Bank offered Rs.90 billion in T-bills at the auction held on Wednesday but accepted only Rs.16.5 billion received at yields which matched the previous week levels of 24.07 percent, 24.69 percent and 24.50 percent for 3, 6 and 12-month tenors respectively. 

“The yield curve shifted more than we expected and that is why we think we need to stabilise the interest rates, and therefore we will intervene,” Central Bank Governor Dr. Nandalal Weerasinghe said adding that they would continue to do so until the yields start easing. 

The data showed that the benchmark weekly average prime lending rate had risen by 13.60 percent and the benchmark 1-year bill yield had climbed 19.25 percent since the Central Bank turned hawkish from August 2021 onwards in response to a cumulative 9.0 percent increase in key rates through April 2022. 

Dr. Weeraisnghe called this was excessive and termed it an “overshoot”, which must be stabilised through interventions via their weekly bill auctions and open market operations where they could inject liquidity. 

The comments by Dr. Weerasinghe reflect that some interventions are warranted to bring sanity when free markets generate undesired and unintended outcomes. 
In its most hawkish pivot ever, the Central Bank shocked the markets by raising its benchmark rates by an unprecedented 700 basis points in April to destruct demand in a bid to ease imports and thereby the pressure on balance of payment deficit, while taming inflation. 

This was done based on its assessment that the rising imports and acceleration in inflation were a result of hotter demand conditions prevailing in the economy at that time. 
However, Dr. Weerasinghe said the current inflation is, “not necessarily”,  generated by demand but by supply constraints, both inside and outside the country and by some of the one-off price adjustments such as in energy and food in response to the steeper fall in the rupee. 

“We see imports coming down; we see the credit growth coming down; we see the monetary policy tightening and the exchange rate depreciation transmitting into the economy to curtail the demand component of that aggregate demand,” Dr. Weerasinghe said.

The Central Bank data showed that the true private sector credit in March had in fact contracted by Rs.18.0 billion after adjusting for the revaluation impact of the sharp rupee depreciation during the month. 

However, there was a sharp change of language from Central Bank officials yesterday since the last Monetary Policy meeting on the true causes of inflation, barring the shock impact from the rupee float.  “Of course the cost push side and the supply side issues that we have to address separately,” Dr. Weerasinghe said.  

“I do not think we should raise interest rates in line with headline inflation under this situation because we see the aggregate demand is slowing down in line with our monetary policy actions,” he acknowledged. 

He said the headline inflation in the next couple of months could peak in the north of 40 percent before starting to ease thereafter with demand destruction policies taking full hold by then. 
 In these circumstances the Central Bank hinted at a potential contraction in the economy as demand destruction measures and the tightened financial conditions could buffet any prospects for expansion. 

Central banks around the world with the exception of China are tightening their monetary policies withdrawing their two years of pandemic stimulus to fight inflation.