On Thursday, the Bank of Jamaica’s Monetary Policy Committee (MPC) unanimously voted to increase interest rates by one per cent to 1.5 per cent. The justification was that the recent inflation out-turn had breached its annual point-to-point target earlier than expected, at 6.1 per cent, reflecting higher food prices, meals consumed from home, and increased prices for services such as education and transport.

In August, the MPC projected inflation would breach the upper limit later, over the first year, starting in the September quarter, with inflation averaging between 5.5 per cent and 6.5 per cent.

Inflation expectations had continued to rise from 7 per cent (last survey) to 7.4 per cent (12 months to July 2022), and were likely to become unanchored and start to affect price-setting decisions in both the goods and labour market. In addition, they argued that upside risks to the inflation target have intensified as international commodity prices and shipping costs have had a stronger-than-expected pass effect through to local prices, further increasing inflation expectations, which were already elevated. This was compounded by the impact of tropical storms Grace and Ida on local prices for agricultural commodities.

In a response to a question as to how the rise in local interest rates could dampen cost-push inflation from supply chain and shipping costs rises, for example China, Dr Wayne Robinson, senior deputy governor at the Bank of Jamaica, argued that the shock from cost-push inflation from increased commodity prices has already happened and so we can’t do anything about the “cost” shock. The concern was that inflation expectations could become imbedded “in people’s minds”, and affect future inflation, so that the key was to “head off” the second-round impact of these shocks that would otherwise mean that inflation could breach the upper limit of the bank’s target for a protracted period. This meant one needs to affect people’s view of where inflation was going and, therefore, the underlying “core” rate.

In this regard, Richard Byles, governor of the central bank, noted that the MPC had observed that, in the last couple of months rental rates had increased significantly, which had nothing to do with corn or oil prices.

Significantly, the summary statement of their discussion noted that, “Consistent with meeting its inflation target sustainably in the medium term, the MPC agreed to continue increasing the bank’s policy rate [and, by extension, raising real interest rates, which are currently significantly negative] and maintaining or intensifying the accompanying measures. This position is subject to inflation and other macroeconomic data evolving as projected.”

Byles, asked whether he had a long-term real interest rate forecast, advised that the bank has a model, but declined to forecast, except that he planned to “watch closely” the inflation outlook. He observed, however, that the one per cent increase was “quite moderate” in his view.

Asked to address the foreign exchange market, Deputy Governor Natalie Haynes noted that the policy was still to avoid a “disorderly” foreign exchange market that would “disrupt” the inflation target and to ensure a balance of demand and supply. Dr Wayne Robinson added that it used to be that a one per cent change in the rate would see a corresponding change in the inflation rate within a year but that, for the last five to seven years, the pass through had been only 40 per cent to 60 per cent within a year, although the pace of the exchange rate adjustment was also a factor.

He added that the rise in interest rates was expected to impact the exchange rate channel, dampening costs of imported goods and “minimising unnecessary and erratic movements in the exchange rate” so as to ensure the foreign exchange market was “as rational as possible”.

Asked whether this was Bank of Jamaica policy response to businessmen hedging their foreign exposure by increasing their prices to reflect their view of where the exchange rate could go, Governor Byles observed it was “rational” for businessmen to increase their prices, but that he wanted the exchange rate “to stay in a more rational corridor”, perhaps closer to $150 rather than $160 to one.

Asked why Jamaica should move ahead of the US in tightening monetary policy, Dr Wayne Robinson observed that the US had an explicit dual mandate of inflation and unemployment, and therefore targeted a “neutral” employment rate. They had also been below their inflation target for a long time, and had moved to targeting an average rate of inflation so that, even though their current inflation rate was above two per cent, it was not yet above this as an average. They were becoming more hawkish, however, tapering earlier, and interest rates could rise next year there.

Governor Byles added that the US has a history of moderate inflation, whereas Jamaica has a history of “higher” inflation, which needed to be taken into account. One of the goals was to make saving in Jamaican dollars more attractive. While recognising that the rise in interest rates would also “dampen demand generally”, Governor Byles maintained their seven per cent to 10 per cent growth forecast for the current fiscal year, citing Statistical Institute of Jamaica’s (Statin’s) release of a better-than-expected second quarter growth out-turn of 14.2 per cent and their expectation that the economy would return to pre-COVID levels by end 2022.

In summary, the issue seems to be whether the risks of future inflation (particularly through inflation expectations) to long-term financial stability are outweighed by potential short-term increases in the costs of lending for, say, residential mortgages and small businesses during a still-depressed economy halfway through a pandemic.