Policy rate cut may boost government domestic financing – Databank Research

The decision by the Monetary Policy Committee of the Bank of Ghana to cut the policy rate by 100 basis points will whip up interest in government Treasury bills (T-bills), as it will reduce appeal for Bank of Ghana’s bills which has been the preference of investors for some time now, Databank Research has said.

According to the research think-tank, when the policy rate was 14.5 percent, the relatively higher-yielding BoG bills appeared more attractive than the 91-day and the 182-day treasury yields, thereby, affecting government’s local financing needs. Hence, a cut in the policy rate to 13.5 percent will divert some interest in T-bills as the BoG bills are always sold at the prevailing policy rate.

The effect of this is that government will be able to generate funds locally to take care of its needs as T-bills is one of the means used to borrow money from the domestic economy. Economist at Databank Research, Courage Martey, threw more light on this in an interview with the B&FT.

“The higher policy rate had attracted funds away from T-bills when their rates fell. So now that the policy rate has been lowered, it would also move some funds to T-bills but not very significantly. There will now be an increase in T-bills due to a reduction of appeal of Open Market Operations (OMO) bills or BoG bills.

Lowering the T-bill rate will allow government to meet its financing requirements because investors may find it appealing now, as it reduces the appeal of BoG bills in favour of T-bills,” he said.

However, other analysts argue a cut in policy rate will rather lead to a decline in the yield on T-bills, hence, investors will still find it less attractive. But Mr. Martey thinks otherwise.

“It would have brought down the T-bill rate if the policy rate had fallen below the T-bill rate. But the policy rate is slightly above the T-bill rate now and so it shouldn’t cause a drop in the T-bill rate. If T-bill rate drops, the problem that the cut in the policy rate is meant to solve will come back again. On that count, we don’t expect the T-bill rate to drop.

Another supporting argument why we don’t expect it to drop is that, despite the MPC remaining bullish on the inflation front, the market remains cautious on the inflation outlook, particularly for the second half of the year. Transport fares has been increased, taxes have been raised, and utility tariffs might also go up, so essentially, the cautious outlook on inflation by the market will also prevent the market from accepting lower yields on T-bills,” he said.

The MPC decision

The Monetary Policy Committee at its 100th meeting said its analysis of the economy shows despite the increment in fuel prices together with the new taxes introduced in the 2021 budget taking effect earlier in May, it is confident that these developments will not lead to a surge in inflation in the near-term, even though such risk could exist in the medium term, hence, the decision to slash the rate by a 100-basis point.

“Headline inflation eased sharply to within the medium-term target band, driven mainly by lower food prices and base drift effects, a tight monetary policy stance and stable exchange rate conditions. Since the initial shock to inflation in April 2020, the forecast showed that inflation will be close to the central target by June 2021. These forecasts remain broadly unchanged, and inflation would remain within the target band in the next quarter.

Risks to the inflation outlook appear muted in the near-term, but pressures from mostly rents and transport fares, would require some monitoring to anchor inflation expectations. Under these circumstances, the Committee decided to lower the Monetary Policy Rate by 100 basis points to 13.5 percent. The Committee will continue to monitor price developments closely and take appropriate action, where necessary, to contain all potential pressures to the inflation outlook,” a statement from the committee said.