Shifting expectation on central bank policy

The policy interest rate was left unchanged at 3.00 per cent, and there were no big policy announcements. 

But there have nevertheless been some key shifts in the policy backdrop in the past two months. 

First of all, the central bank has become much more cautious on Thailand’s economy. A global slowdown has had a bigger-than-expected impact on local activity, and may lead to a more subdued second half of the year. The central bank has revised down Thailand’s growth forecast for 2012 from 6.0 to 5.7 per cent.

While growth of over 5 per cent may sound good, it is partly due to the low base from last year when growth was just 0.1 per cent. Looking at a wider horizon, 5 per cent growth is not quite enough to get the economy back to its pre-flood track. 

Secondly, the inflation outlook has become more moderate. Due to lower commodity prices and muted domestic demand, the central bank’s inflation forecast has been lowered from 3.5 to 2.9 per cent. 

These changes are reflected in the tone of the central bank’s statements. The BOT notes that growth risks are more important than inflation concerns. Two out of seven committee members wanted to lower the policy interest rate at that last meeting. 

Shifting expectations about the path of the central bank’s policy rate have affected local rate markets. The bias for the policy rate is down, rather than up as it had been early in the second quarter of the year. Reflecting these changes, two-year government bond yields fell from 3.26 per cent at the beginning of July to a low of 3.01 per cent last week, though it has since risen back slightly. 

Markets will continue to closely follow local economic figures (particularly exports and manufacturing) and the global situation (especially growth trends in China and the United States). If the data is poor, then local rate cuts will be quite likely and will have to be priced in by markets. 

While interest rate expectations naturally have an impact on local interest rate markets, there is less of an impact on foreign exchange markets. 

This is partly because there are similar monetary policy issues being played out in other central banks in the region as well, with rates in general biased downwards. 

Also, trading in foreign exchange markets is dominated by daily changes in risk appetite. This depends on news flow out of Europe (on the viability of the euro) and the United States (on whether or not the Federal Reserve will implement a third round of quantitative easing and money printing). 

There is an ongoing debate about the direction of Thai monetary policy. Some policymakers have called for the central bank to lower rates in order to boost growth, and not to worry so much about inflation. While there are clear differences of thought in terms of foreign exchange rate policy management, the two sides are less far apart than it may seem on interest rates. 

 

Parson Singha is chief markets strategist in the Global Markets Dept at HSBC Thailand.