Policy rate reduction to induce inflation

A local investment management and advisory firm fears that the recent reduction in the policy rate to 22.5 percent will prompt an increase in liquidity and push up inflation.

After maintaining the policy rate at 25 percent since December 2012, last month, the Monetary Policy Committee (MPC) resolved to reduce the policy rate by 2.5 percentage points to 22.5 percent based on an analysis of factors including inflation, money supply, fiscal developments, foreign exchange reserves, and financial stability concerns.

Nico Asset Managers in its July 2014 economic report has pointed out that due to the reduction in the policy rate there will be an increase in inflationary pressures due to an increase in liquidity which in turn will lead to demand pull inflation.

But the Reserve Bank of Malawi (RBM) spokesperson Mbane Ngwira in a telephone interview with Business News on Tuesday said that the policy rate reduction was a balancing act between growth and inflation.

“Based on inflation projections, operations and the factors that cause it the policy rate reduction will bring up low credit levels to desirable levels and prompt growth,” said Ngwira noting that the policy resolution is forward looking.

The Blantyre based investment advisory firm has argued that the reduced monetary policy rate will result in increased borrowing which will increase liquidity levels, lead into higher liquidity levels, an increase in disposable incomes and higher demand for goods and services.

And as inflationary pressures increase, the prices of goods and services may start to increase, leaving less disposable incomes for both firms and households, the firm has noted.

Consequently, the report has noted, higher inflation rates will lead to higher interest rates thereby affecting lending rates which will decrease the amount borrowed, decrease disposable income for spending and investments as the real return declines.

Nico Asset Managers has also added that higher inflation will also put pressure on the currency to depreciate.

Malawi’s inflation fell by 0.2 percentage points to 22.3 percent in July as food inflation increased to 20.3 percent from 19.9 percent while non food inflation decreased to 24.9 percent from 25.7 percent.

Recently, the Reserve Bank of Malawi (RBM) said it expects inflation to reach 20.5 percent in December 2014.