May 2010 Monetary Conditions Update

I missed doing a post on money and interest rates in April, so this post will be an omnibus edition.

The money supply situation hasn’t changed a great deal over the first half of this year, although we’re well below the growth rates seen in 2004-2008:

Far more interesting is what’s happened to interest rates, as we’ve had of course two hikes of 25 basis points each in the Official Policy Rate or OPR (for a cumulative total of 0.5%) since March. Interbank market rates have generally risen as a consequence:

…as have lending and deposit rates:

Note, however, that the average lending rate is lagging considerably behind the published Base Lending Rate (BLR), as it takes a few months to administratively adjust borrowing rates for floating rate loans such as housing.

What’s really interesting is what’s happening to MGS yields over the past couple of months:

The yield curve is getting flatter, which can be interpreted in a number of ways. First recall that the Greek debt crisis blew up with a bang in early May, which may have contributed to rising yields at the short end – but I doubt it. The conventional explanation for a flattening yield curve is either slowing economic growth seen ahead, or reduced inflation expectations. Both of these are plausible, especially the former as fiscal austerity in Europe and mixed signals from the US indicate. But the simplest explanation turns out to be demand and supply:

Redemptions of MGS coming due reached nearly RM11 billion in April, and was only partially offset by about RM5.6 billion in a new tender. A reduction in supply relative to demand will, all things equal, increase the price of MGS – since the yield is inverted, that equates to a fall in the yield. But going back to the yield curve chart above, the yields fell at the long end but rose at the short end over the last couple of months, which suggests that the incoming new MGS for April had shorter maturities than those redeemed. May 2010 on the other hand saw virtually no activity at all, as that’s when the bulk of personal income tax is paid to the government (even with PAYE schemes).

The pace of borrowing over the next few months will depend on how much income tax the government will be able to collect, both for personal taxes as well as corporate taxes which should come in next quarter. Nominal GDP fell 9.1% last year, but the government is forecasting an 8.4% drop in revenue for 2010 – that sounds plausible, given the recovery in commodity prices late last year. Up to yesterday, there’s been an additional RM5.5 billion in MGS and GII issuance – unfortunately I can’t tell as yet whether this is for rolling over maturing debt, though current market indicative yields (down a further 10-15bp from May) suggest it is.

As for as the outlook for the OPR, I’m of the opinion that there should be a pause in the interest rate normalisation process – the Monetary Policy Committee will be meeting next week, and we’ll know by then. With the growth outlook seeming less certain, I think there’s an argument for holding off any further interest rate increases until the external situation resolves itself one way or the other.

On the other hand:

Loan growth is starting to look excessive, and May industrial production data around the region have shown bounces relative to April. So I suspect that BNM will raise rates anyway, even knowing that the effect on the economy will only operate with a 3-6 month lag. That’s always been the pitfall of monetary policy – though to be fair, fiscal policy lags are even worse.