Monetary Policy Discussion and Decision
At its meetings on 16 and 17 August 2022, the Monetary Policy Committee (MPC) noted that, having peaked earlier and lower than expected in April 2022, inflation at May and June were both 10.9 per cent, followed by 10.2 per cent at July. Declining international commodity prices, relative stability in the exchange rate and higher interest rates, have allowed for this trend. The MPC however noted that the conditions that led to the recent inflation outturns appear to have not sufficiently solidified to ensure that inflation is sustainably on a downward path, and there remains a risk of reversal. The low unemployment rate, reported labour shortages in selected sectors of the economy and pressures from the acceleration in domestic inflation carry the potential for future wage adjustments to exceed that required for the consolidation of low, stable and predictable inflation. Inflation expectations also remain elevated and, without stronger policy actions, may continue to rise. Finally, high inflation in the US and other trading partners has prompted a programme of faster monetary adjustment among the central banks of the advanced economies, which could cause capital outflows from Jamaica and a faster pace of exchange rate depreciation if domestic monetary policy is not properly aligned.
Therefore, to mitigate these risks and to facilitate a return of inflation to the target range in the shortest possible time period, the MPC unanimously agreed to further increase the policy rate by 50 basis points (bps) to 6.00 per cent. The MPC also agreed to continue pursuing other measures to contain Jamaican dollar liquidity expansion and to maintain relative stability in the foreign exchange market. The Committee noted that the Bank’s continued strong international reserves reinforces its ability to continue supporting the foreign exchange market, as needed. The MPC will continue to closely monitor the global and domestic economic environment and is prepared to pause its monetary policy tightening if the incoming data continues to reflect a downwards track for inflation.
The MPC noted that its current decision has resulted in a cumulative increase in the policy rate of 550 basis points since October 2021, which has taken the policy rate to a level that the Committee tentatively considers to be appropriate. Since October 2021 to date, the Bank, while maintaining a flexible exchange rate, has taken strong actions in the foreign exchange market including an adjustment to the Net Open Position limits for deposit-taking institutions (DTIs) and the sale of foreign exchange to the market, when necessary, while continuing to ensure that the gross reserves remained comfortably above the level considered adequate. These policy actions contributed to the maintenance of stability in the foreign exchange market and, without them, imported inflation and hence the final prices faced by consumers would have been higher. At 16 August 2022, Jamaica’s gross reserves amounted to US$4.3 billion, which represented approximately 124 per cent of the projected IMF’s Assessing Reserve Adequacy (ARA) measure for FY2022/23.
The measures are expected to cause interest rates on deposits and loans to rise further, making savings in Jamaican dollars more attractive relative to foreign currency assets and borrowing in Jamaican dollars more expensive. They are also expected to reduce the demand for foreign currency, leading to a relatively more stable exchange rate. The measures are also intended to constrain aggregate demand in the economy and, consequently, limit the ability of businesses to pass on price increases to consumers. Since the commencement of the Bank’s policy actions, some DTIs have adjusted interest rates on deposits and loans.
The following considerations helped to inform the Committee’s decisions:
- Inflation is projected to fall within the target range by the December 2023 quarter. This is two quarters later than previously projected. Consistent with consensus forecast for a fall in commodity prices and the Bank’s overall monetary policy stance, and absent any new shocks, annual inflation is projected to range between 9 per cent and 11 per cent for the remaining months of 2022. Inflation is projected to fall to single digits in early 2023, as long as the conflict between Russia and Ukraine do not escalate and inflation among Jamaica’s trading partners continue to fall. In addition, the Bank’s baseline forecast assumes that the public’s expectation for future inflation will fall during the second half of 2022.
- The near-term risks to the inflation forecast are assessed to be balanced, which means that actual inflation could be in line with the forecast. The factors that could cause higher inflation include further disruptions to international supply chains, higher than anticipated pass-through of imported inflation to domestic inflation and a reversal in the trends in commodity prices. The rebound of the domestic economy and the additional demand for labour that this brings may contribute to further upward movements in wages and hence prices. On the downside, weaker than expected global growth could negatively impact domestic demand. There is also a risk of lower than projected imported inflation from international commodity prices, given the headwinds to global growth.
- The Jamaican economy continues to perform creditably. There are signs that the economy continued to expand for the June 2022 quarter and during the September 2022 quarter. In this context, the unemployment rate fell to a historic low of 6.0 per cent at April 2022.
- Domestic economic activity is projected to return to pre-COVID-19 levels by early 2023. In this context, GDP growth for FY2022/23 is projected to moderate to the range of 2.5 to 4.5 per cent from the growth of 8.2 per cent in FY2021/22. This is broadly similar to the Bank’s previous projection. GDP growth is projected to be driven by the services industry, particularly tourism, which has been recovering at a surprisingly rapid pace. There has also been some buoyancy in the agricultural sector, which is expected to continue as the tourism sector recovers and weather conditions remain favourable. The forecasted growth also reflects the resumption of production at the Jamalco alumina plant.
- The risks to the domestic GDP forecast are skewed to the downside, which means that GDP growth could be lower than the forecast. Growth in tourist arrivals and related activities could be adversely affected by the strong headwinds to global growth. External demand could also be lower than anticipated due to a strengthening of geopolitical tensions. There are also downside risks from new pandemics. More severe weather in the context of climate change also poses a downside risk to GDP growth. Finally, there is a risk that domestic consumer spending could be adversely affected by the high, albeit falling, domestic inflation.
- The forecast for US GDP growth over the next two years has been revised downwards. This revised growth outlook reflects the impact of high inflation on consumption, tighter monetary conditions and reduced fiscal support. Inflation in the US was 8.5 per cent at July 2022, lower than the outturn of 9.1 per cent at June 2022 but above the Fed’s target of 2.0 per cent. The Bank projects that inflation in the US will continue to fall. In the context of the above target inflation, the Fed increased the policy rate by 75 bps in July 2022, a cumulative increase of 225 bps since it began its tightening cycle in March 2022, and indicated that additional rate hikes would be forthcoming. Bank of Jamaica anticipates that the Fed will raise interest rates in its remaining meetings for 2022 by an additional 100 bps.
- The risks to the outlook for the US economy are skewed to the downside, primarily related to the possibility of escalating geopolitical tensions, which could lead to further trade disruptions and supply shortages. Additional downward pressures could come from the possibility of new pandemics as well as the unanticipated impact of the tightening in monetary policy in that country.
- The domestic fiscal policy stance continues to pose no risk to inflation over the near term.
Chairman of the MPC
18 August 2022