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Published on April 23, 2008

The sub-prime debacle has had a ripple effect on financial markets in the United States and Europe and resulted in as much as a 1.25-percentage-point cut in the US Fed Fund rate in the first month of the year. The rate has been constantly cut from 4.25 per cent late last year to 2.25 per cent. The key US rate reduction has had a psychological impact on the direction of interest rates in other countries, including Thailand.

Interest rates will drop only marginally, due mainly to rising inflation.

However, from the end of the first quarter to this month, there have been signs of sluggish investment in the debt market.

1. Inflation has risen since January and became a closely watched factor in March due to global oil prices rising to above US$110 (Bt3,500) per barrel. In addition, rising rice prices have consequently increased the cost of consumer products and lifted inflation over the past two months. Despite the spread between the US and Thai policy rates of 1 percentage point, the possibility that the Bank of Thailand will cut the policy rate following the US central bank is low, due to higher inflation.

2. Demand for new bonds in the primary market and the trend of the supply has increased, due to the government's economic stimulus package. In addition, recent uncertainty over the US central bank's rate movement has created volatility in its debt market. For example, in March to April, the bond-yield spreads between two-year and 10-year US treasury bonds fell to 150 basis points in April from 200 basis points in March.

3. The bond yields of all maturities have risen since the expectation subsided that the Bank of Thailand would further cut the policy rate from 3.25 per cent. For example, the five-year bond yield has risen 0.3 percentage point in the past month to 3.9 per cent.

These factors have made the outlook for the debt market gloomier in the short term amid the volatility of yields.