BOJ balancing geopolitics, FX market and expectations
Published:Wednesday | February 23, 2022 | 4:52 AMHuntley Medley/Associate Business Editor
Faced with continued price increases that have proven more stubborn that initially anticipated, the central bank is keeping a keen split screen focus on several local and global drivers of inflation, at the ready to engage various policy levers for monetary control it has as its disposal, in a bid to beat back inflation from the current 9.7 per cent to the 4 to 6 per cent range within which the Bank of Jamaica, BOJ, is statutorily mandated to keep price escalations.
The oil price implications of global geopolitical tensions have taken centre stage internationally as an inflation push factor. But BOJ officials seem more concerned about local issues such as spiralling inflation expectation, and pressure on the Jamaican dollar from a flight to foreign currency saving as an inflation hedge as well as to cash in on US interest rates that are set to rise next month.
As BOJ Governor Richard Byles spoke to journalists at a monetary policy briefing on Monday, tensions in Eastern Europe had ratcheted up several notches as Russia defied international law and diplomatic overtures by reportedly sending more troops into eastern Ukraine, sparking sanctions by the United States and European nations.
Russia is a major global supplier of oil and grain, important determinants of inflation. Even Jamaica’s increasing use of liquefied natural gas, or LNG, is not sufficient insulation, given the knock-on effect of oil price increases on the cost of natural gas. Oil prices skirted the US$100 at US$99 on Monday.
“As oil prices rise, the cost to us in foreign currency gets higher. We watch oil prices generally, but with an even keener eye we watch LNG prices. But once oil prices and a drag-along LNG price gets too high it going to be costly to us,” Byles said.
Deputy BOJ governor Robert Stennett said the central bank is keeping a close watch on the impact of oil on inflation, foreign currency demand and balance of payments.
“If oil prices were, for example, to go above US$100 and remain there for, say, two quarters, it could have the effect of pushing inflation temporarily higher by between 1.0 to 1.5 percentage points over that period.” said Stennett.
“For the balance of payments, the implications for imports and FX demand is similarly stark. A similar shock would cause the trade balance to be wider by upwards of US$150 million per year. And of course, once FX demand rises, the central bank would have to be more sensitive to the impact of that on the exchange rate,” the central bank added.
Despite this stark scenario, the BOJ official said the central bank’s projection is for geopolitical considerations to wane over time and the global oil price effect on local inflation to moderate.
“Our view is that oil and LNG prices are unlikely to stay this high because geopolitical tensions are essentially flavours of the day. What is happening in Russia now is already being countered by the potential of the US and Iran brokering an agreement that would increase world supply. So, as soon as these geopolitical tensions dissipate, we anticipate that the natural growth in oil supply that is brought on by OPEC and by the other oil producers, particularly in the US, coming on stream, are likely to satisfy the growth in demand that is emerging. And so, our baseline view is that energy prices should come down, but of course, we are prepared for the worst,” said Stennett.
Still, BOJ expects inflation could continue breaching its target range for another 10 to 12 months.
Local inflation expectations and behaviour of the foreign exchange market, more than global considerations, appear to the big determinants of the policy response by the central bank.
BOJ increased the policy rate it pays on overnight deposits by a total of 200 basis points between September and December last year and again by another 150 basis points on Monday, bringing the rate from 0.5 per cent to now 4.0 per cent.
The BOJ governor made clear that the central bank has no fixed ceiling for rates.
“We move it, we see how it works its way through the transmission system, we see what the reaction is. We see what happens on the lending rate side. We see what’s happening for the demand for foreign currency, where is the exchange rate, and then we decide at the next meeting what is it we need to do. if anything more, to address this issue,” he said.
Inflation expectation for December was an annual 9.1 per cent – substantially above the outturn of 7.3 per cent, as measured by Statin. Additionally, the expectation is that annual inflation will track at 9.8 per cent over the 12 months of calendar year.
“We look at inflation, not just as it is today or has been, but what we expect in the future. So, if we understand that the factors that are driving inflation may be temporary, then the way in which we move our policy rates is different than if we think inflation may be here for quite a while, or that, it’s the monetary situation in Jamaica that is having a significant effect on inflation,” the central bank governor explained.
“A major objective of why we are moving the rate is to make a depositor or Jamaican dollars or the holder of a Jamaican dollar investment asset get more, so that they are not as tempted to go and buy US dollars and invest in a US dollar security,” he added.
Meanwhile, the central bank head is placing squarely on the shoulders of banks and their customers the issue of spreads between savings and lending rates.
“They (banks) need to balance increasing that rate and the impact it will have on their customers. And I’m sure that’s what they do in a very sensitive way, when they are making those adjustments. Every depositor in Jamaica should understand that now that BOJ has moved its rate from 0.5 to 4.0 per cent they should be getting a better rate on their deposits, and if they are not, they need to ask why,” Byles said.