Tue | Mar 20, 2018

BOJ to transition policy rate by end June

Published:Friday | May 12, 2017 | 12:13 AMMcPherse Thompson
John Robinson, Senior Deputy Governor of the Bank of Jamaica.

The Bank of Jamaica (BOJ) will be fully transitioning its policy rate from the 30-day certificate of deposit to the overnight rate by the end of June as part of the steps to further shift towards inflation targeting.

Inflation targeting is a monetary policy regime in which a central bank has an explicit target inflation rate for the medium term and announces this target to the public.

The transition is also part of the efforts to further boost central bank autonomy and improve monetary operations, according to the April 2017 country report on Jamaica by the International Monetary Fund (IMF).

Building the foundation for inflation targeting also requires the government to revise the BOJ Act, in consultation with the Ministry of Finance and the Public Service, to further strengthen the central bank's governance, accountability and operational autonomy.

A new IMF structural benchmark calls for the proposal to be submitted to Cabinet by the end of August 2017, with a view to submitting the revised law to Parliament by February 2018.

The IMF report noted that in early March, BOJ narrowed the interest rate corridor from 425 basis points to 300 basis points by reducing the overnight lending rate from 7.25 per cent to seven per cent and raising the overnight deposit rate from three per cent to four per cent.

Asked about the rationale for transitioning the policy rate, BOJ Senior Deputy Governor John Robinson told the Financial Gleaner that as a general rule, countries which undertake inflation targeting use the overnight rate as the policy rate.

"What is common among those practices those who practise that is that a change in policy gets transmitted throughout the spectrum of rates very quickly," he said.

"We believe that operating at the very short end of the market, where people who supply credit immediately feel the impact of a change in policy, is likely to transmit the impact of that policy change throughout the financial markets more effectively, more quickly, more sharply than our current practice of just shifting the CD rate to a 30-day."

CD issues reduced

Robinson said the central bank has already reduced the number of CD issues.

"We used to do it every day. We've now reduced it to once a week and when we do transition to the overnight rate as the policy rate then the issue of 30-day CDs will be by auction," said the central banker.

He added: "There will be one rate in the market, that is the overnight rate, which is currently 3.75 per cent, and everything else will be market-determined. So we are going to be setting the overnight rate for deposits and overnight rate for lending as we currently do and every other rate will take their signal from that."

Robinson said the central bank was relying on its "knowledge of the transmission mechanism, our adherence to the best practices with respect to using the interest rate as the key control mechanism, the key signalling method for monetary policy change, and moving to that as quickly as we can."

The transmission mechanism is the process by which asset prices and general economic conditions are affected as a result of monetary policy decisions.

The current policy rate is the 30-day rate, which stands at 4.75 per cent, while the current overnight rate is 3.75 per cent for deposits, whereby banks which have excess liquidity place it with the central bank overnight.

As for the switch to the overnight rate, "I think it will provide a clearer signal of what the policy stance is by the BOJ and by so doing, I think it will transmit that policy stance throughout the financial markets, throughout the economy, much more effectively than it probably does now," he said.

The transition will impact interest rates at commercial banks. "That is the reason we change policy rates, so that when you reduce rates, you expect credit conditions to eventually become easier; when you raise rates, you expect them to tighten," Robinson said.

"So we think that starting the adjustment process from the overnight rate is most likely to lead to a more effective transmission of that policy intention throughout the market."