THE JURY is out on whether Cyprus will cut interest rates today in a bid to narrow its wide gap with euro zone levels, or hold its firepower because of an April spike in inflation.
With the country now in the EU’s Exchange Rate Mechanism (ERM-2), analysts say the spread between the 4.25 per cent Cypriot minimum bid rate and the 2.0 per cent of the eurozone is bound to be narrowed, but are divided on the timing.
“Its anyone’s guess,” said economist Pambos Papageorgiou at Cyprus College.
The Central Bank and the rate-setting monetary policy committee meet today in their first session since Cyprus joined the ERM-2 euro waiting room on April 29.
Cyprus will spend a minimum two years in the currency stabilisation band before ditching the pound and adopting the euro as its currency.
“We are expecting an adjustment on Firday, 25 to 50 basis points. The central bank is quite conservative so it may not be more than 25 basis points because of inflation,” said Yiannis Telonis of Hellenic Bank.
Treasury manager Demetris Hasikos of the Co-operative Central Bank was more cautious. “I think it is too soon. There are high deficits, inflation is high, why reduce it now when there are two years ahead of us?”
April inflation climbed to 3.08 per cent from 2.89 in March. “If it is anything more than a cut of 25 basis points that may suggest they have some information at their disposal suggesting inflation is now coming down,” Telonis said.
Finance Minister Makis Keravnos fuelled speculation of a possible decline in rates two weeks ago, telling parliament ERM-2 created conditions for the convergence of interest rates to the benefit of borrowers.
Papageorgiou said reading the economic runes gave a contradictory picture. “It seems growth is quite robust at 4.0 per cent this year and inflation is high. They are both reasons not to lower rates.”
“On the other hand there are monetary reasons to reduce rates. Our spread is huge, if we don’t lower we could eventually have potential distortions,” he said.
Those distortions could either come as pressure on the local currency from a rush to cheaper borrowing in euros, or conversely, a rush to buy higher-yielding Cypriot government bonds and deposits, both costly options in the long run.
“I think they will wait. There is a sense that Cypriot rates will eventually come down but to predict what they will do in the short term is impossible,” Papageorgiou said.
