Analyst Insight
Introduction
The current monetary policy rate, the rate paid on overnight deposits of Deposit-Taking Institutions (DTI’s) at the Central Bank currently stands at 7.0%. This comes as the Bank of Jamaica (BOJ) raised rates for the first-time effective October 2021 from 0.50% to 7.0% on November 2022, and has paused since then. The pause, at the time it was initially announced, occurred in the context of the following factors which we have deemed important, namely:
- Favorable expected inflation trajectory. In November 2022, the BOJ was projecting inflation to fall
to its target band of 4-6% by December 2023. - Continued strong domestic GDP growth.
- BOJ expectation of a pause in the Federal Reserve hiking cycle mid to late 2023. Connected to this
is the expectation of a continuing albeit less negative rate differential with the US.
Hence in this piece, we will go over the importance of these points and how they have developed since the BOJ first announced its intentions for a pause, and how their trajectory likely impacts the monetary policy stance.
Despite this seemingly more restrictive monetary policy condition, the domestic economy has continued its strong growth. This is led by an overperformance of the tourism sector. To place this into perspective the BOJ in their November 2022 forecast expected growth to be within the region of 3.0- 4.5% for Fiscal year 2022/23. This compares to actual growth of 4.7% for the 2022/23 fiscal year. Further to this, growth is projected to be to the tune of over 2% in the long run (based on IMF forecasts) which is notably above the historic rate of growth of Jamaica. This potentially points to growth being above potential, with this being highlighted in the local media recently by the BOJ. Above potential growth essentially means the economy is producing above its long-run capacity which tends to be inflationary over the long run.
Exchange rate, NIR, and US interest rates
While they do not state it explicitly, the exchange rate is an effective tool in controlling domestic inflation. Notably when the pause was announced, the BOJ still made clear their intention to restrict J$ liquidity to ensure stability in the exchange rate market and temper pass-through inflation (a more depreciated currency leading to higher domestic prices for imported goods). At the time the NIR was deemed adequate to enable intervention if needed. Since then, the NIR has grown to a record US$4.3
billion. Meaning the BOJ likely has ample power to maneuver in the foreign exchange market.
One of the key drivers of the Exchange rate particularly in the short run however is the monetary policy stance of the US. Hence the BOJ will and has been monitoring this closely to keep this rate differential manageable. To understand how this impacts devaluation think about current rates, with 6-month US treasuries as of July 10, 2023, trading at approximately 5.53% vs 7.86% for our domestic 6-month tbill. In this scenario, if you expect the currency to depreciate by more than the rate difference, the US Tbill becomes more attractive. Now imagine if people think this en mass and opt to sell J$ for US$. Hence keeping the interest rate differential low reduces the demand for foreign investment products. A high enough differential can also outweigh expectations of depreciation further bolstering the relative attractiveness of J$ products.
So what’s the bottom Line?
Now in deriving our view on the monetary policy’s short-term outlook, we pull these different facts together. There has been a significant improvement on the inflation front which has likely made the current monetary policy stance more restrictive. This is somewhat counterbalanced by evidence suggesting that growth is currently above potential and hence has the potential to be inflationary in the medium to long term. In this case, barring shocks to inflation we would not expect the BOJ to enact drastic cuts given the potential to overheat the economy in the medium term, despite inflation falling back to target in the near term.
Cyber-attacks and Cybersecurity in Jamaica
Cybersecurity and the threat of cyber-attacks are global concerns, and Jamaica is not exempt from these risks. Like many other countries, Jamaica faces cybersecurity challenges due to the increasing reliance on technology and connectivity. The country’s growing digital infrastructure, including internet usage and e-commerce, presents opportunities for cybercriminals to exploit vulnerabilities. In 2023, there have been a few notable cyber-attacks in Jamaican, including an attack on one of the countries most prominent financial institutions by the Play Ransomware Group.
Given the current band for what is commonly thought to be neutral rate territory (give or take +/- 2.5% in real terms) assuming inflation and inflation expectations fall back to the midpoint of the target band by year-end or early 2024, there is a slight scope for a cut in rates before we re-enter a neutral territory (enter the midpoint of neutral territory). However, the aforementioned guesstimate that the economy is running above potential, in our opinion may stop the central bank from considering deeper cuts into less neutral/accommodative territory. This may translate to a longer pause and when the cuts do happen, they are likely to be more moderate.
In summary, there are plenty of conflicting indicators. The fast decline in inflation is counterbalanced by the potential medium to the short-term risk of demand-pull inflation and the need to maintain a rate differential to boost J$ asset demand and slower imported inflation to mitigate upside inflationary risks. These culminate in our belief that any possible rate cuts are likely to be moderate initially in the medium term. In summary rate cuts next year are not off the cards, but don’t expect pre-pandemic
lows given the strong domestic economy. Regards
Written by Peter-Geroge Simon
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