Governor of the Bank of Jamaica Derick Latibeaudiere.
ON MONDAY, the Bank of Jamaica (BoJ) reduced rates on all open market instruments the second time since the start of the year. Citing the stability of the economy and a single-digit inflation rate in 2005, the central bank says it expects rates to trend further down.
The current interest rate reduction represents a significant point of reference, as the last time that the interest rate yield curve on Bank of Jamaica instruments was at this level was in September 2002, and the prospect of further reductions represents breaking new ground for the economy and the central bank.
The last time that the rate on the 365-day instrument (which came into existence in September 2000) was at this level was February 2003. At that time this rate had reflected a series of reductions since a peak at 22 per cent in November 2000.
CONTINUED REDUCTION
The current rate on the
365-day instrument reflects a continued reduction since a peak of 35.95 per cent in March 2003, in a period when monetary policy was tightened in reaction to financial market instability.
Similarly, the bank's 30-day instrument was last at this level in February 2003, then reflecting a gradual reduction since peaking at 29 per cent between December 1997 and March 1998. The current rate on this instrument also reflects a sustained but more gradual reduction in rates since being raised to 15 per cent in March 2003, when monetary policy was temporarily tightened due to prevailing conditions at that time.
The BoJ cut interest rates 11 times in 2004, and has so far cut interest rates twice since the start of 2005. This latest reduction also comes on the heels of a loosening of one other arm of monetary policy on March 1 a reduction from three to five per cent in the special deposit ratio requirement for the banking sector.
In the same manner that the temporary hike in interest rates in 2003 was a tightening of monetary policy in response to adverse macroeconomic condi-tions at that time, the sustained reduction in rates undertaken by the central bank has been in response to those conditions improving significantly since then.
These improved conditions include a marked increase in local and international investor confidence, and a very stable foreign exchange market, which in turn has been underpinned by factors including the following:
A significant improvement in government's fiscal position, which enabled it to return to the international capital market and decrease the demand pressure in the domestic debt market;
Buoyant foreign exchange inflows from tourism and remittances;
Increased investment inflows and prospects of inflows in tourism and other sectors which have combined to increase optimism in macro-economic conditions;
A level of foreign exchange reserves adequate to underwrite any short-term disruption to market stability
The BoJ's demonstrated commitment to keep a tight grip on the inflation factors within its control.
IMPROVEMENT EXPECTED
Going forward, the bank expects these conditions to continue, if not improve.
The shock of two hurricanes, followed by the current drought and outbreak of bush fires in agricultural areas, combined to derail the economy's ability to return to single-digit inflation in calendar year 2004 or within the current financial year. It is significant to note, however, that prior to the impact of Hurricane Ivan, the economy was on track to achieve single-digit inflation in spite of the impact of higher than normal oil prices since late 2003.
This factor underpins the bank's expectations that barring any major shock to the economy, the country should see a return to single-digit inflation in 2005, and the significant post-Ivan decline in inflation levels since November has reinforced these expectations.
The expected return to single-digit inflation will allow the financial markets to realise an improvement in real interest rates even as the economy adjusts to a lower interest rate environment.
