IEA forecasts 2% increase in policy rate to 26.5%

The Institute of Economic Affairs is forecasting an increase in the Policy Rate (PR) by 200 basis points to 26.5% when the Governor of the Bank of Ghana announced developments in the Ghanaian economy on Monday, November 28, 2022.

According to the institute, the significant gap between inflation and the policy rate has compelled banks to access Central Bank funds at cheaper rates and on-lend to the government at higher rates, which is impacting negatively on the economy.

The expected increase in the policy rate will further increase the cost of lending and consequently cost of doing business.

“The decision regarding the PR is rather tricky—and challenging—at this time. We note that a significant gap has opened between the PR, at 24.5%, and inflation, at 40.5%. This is not uncommon. However, it rather unusual, especially in the Ghanaian context, where the real PR has been, more often than not, positive. Similarly, the PR has fallen far behind Treasury Bill rates, which are over 35%”, it stated in a statement signed by the Director of Research, Dr John Kwakye.

“This has caused misalignment between the rates and increased the potential for “round-tripping,” to the extent that it is possible for banks to access Central Bank funds at cheaper rates and on-lend to the government at higher rates. It is also the case that major economies, such as US and UK, have further tightened their policies, increasing the pressure on the currencies of emerging markets and developing countries”, it explained.

Furthermore, the IEA said pressure will mount on the PR since the Bank of Ghana and the government are not implementing adequate intervention measures to target directly the underlying causes of inflation, pressure will mount on the PR, adding, “already, interest rates have reached prohibitive levels and hurting the real economy as the cost of doing business has escalated. Reducing the growth projection for 2022 from the original 5.8% to 3.7% in the Mid-Year Budget attests to a slowing economy”.

Notwithstanding, the IEA said inflation is of greater concern and must be the first target of policy, noting “our view is that inflation may go up further in November [2022], reflecting the pipeline pressures, before possibly slowing in December [2022], reflecting the slight decrease in fuel prices and a measure of stability on the foreign exchange market”.

Again, it said some further increase in the PR may be necessary to consolidate the incipient stability and reassure the markets of the strong commitment to fighting inflation. From that standpoint, I expect the PR to be increased by 200 basis points to 26.5%”.