Saturday, May 2, 2009

Monetary Policy Update I

Since BNM has opted not to change the OPR from the current 2.0% level, have there been any substantive changes in the monetary policy stance? Are they putting monetary easing on hold with expectations of a recovery in the second half, or is something else going on?

The three instruments of monetary policy are interest rates, money supply and the exchange rate - I will deal with the latter two in separate posts. There's a few interesting things happening on the interest rate front.

The OPR as a policy instrument is aimed at putting a band around the interbank overnight rate. On that score, March data shows market rates right on the money:

In fact, the spread between the overnight rate and 6 month money is a ridiculous 8 basis points.

Yields on BNM bills and Treasury bills have fallen in tandem, though it’s hard to say where the real market lies with these assets because volume is either low or non-existent. There's just enough action on T-bills though to show the yield curve is still inverted (for the third straight month), while flattening slightly:

The movements in MGS yields in March are fascinating. Recall that the mini-budget was tabled in the first week of March, and we already saw a general movement toward the short end with spreads on longer term yields up sharply across the yield curve. With the expected federal borrowing requirement now known, the market acted accordingly:

The yield on the extreme short end fell, but medium term yields reflected the potential supply situation. I'm a bit at a loss to explain the compression in spreads at 10yr maturities and above, unless it’s because recent auctions have concentrated on medium term maturities - the three MGS auctions in March were for 3 year and 5 year terms. The latest data shows yields on these maturities still inching up. On the other hand, it looks like the market is well able to digest planned government borrowing, RM60 billion stimulus package and all, with yields about on par with the last couple of years.

More importantly for the domestic impact of monetary policy is the continued fall in average lending rates (here for commercial banks):

...and net of inflation:

However, this is still a little higher than I'd like. Despite the fall in lending rates, it's still lagging the cuts in the OPR - the spread between lending rates and overnight interbank money has actually been rising since November, and is at the highest point since early 2006:

This is probably reflective of perceived higher default risks, although we probably won't see any upward movement in delinquent accounts until the second half of the year.

With inflation as it is, the OPR and interbank rates are resoundingly negative which should be a strong enticement to banks to lend. While loan growth has held up (which I'll cover in the next post), there is still a lot of caution and fear - note the massive RM173.5 billion on deposit with BNM, despite the cut in the SRR to 1%. The only positive I see here is that both interest rates and net lending margins are lower than they were in the last downturn in 2001, but since the scale of this downturn is more severe, that's cold comfort.

Technical Notes:
All interest rate data from March 2009 Monthly Statistical Bulletin. Inflation is based on log annual changes to my spliced Consumer Price Index (2000=100).

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