Copying US inaction amid inflation carries risk

One view we subscribe to is that the Fed could lose more credibility than it already has by making an about-turn on policy rates. That tune is similar to "data driven", as William Poole, a former president of the Federal Reserve Bank in Saint Louis, Missouri, said in a recent interview.

Ben Bernanke, after taking the helm at the Fed from Alan Greenspan, raised interest rates once to 5.25 per cent and began to use that phrase, "data driven". It was then accompanied by a long pause from July 2005 to just before the aggressive cuts starting last September.

Thailand will likely soon join the club of inflation targeters not upholding their mandate by keeping inflation benchmarks within their bands. Romania, Brazil and Thailand are still within limits, but for how long

While last month's reading for core inflation may still be below the 3.5-per-cent upper core-inflation limit, the combination of elevated commodity prices and a weak baht will most likely prompt the Bank of Thailand (BOT) to offer an explanation to the public soon about why it failed its mandate.

Chances are the BOT will follow the herd mentality and like other central banks, such as Indonesia's, pursue monetary tightening. Of course, fixed-income investments will continue to be under a selling bias.We feel raising interest rates will more likely aggravate inflation further, because interest expense is a cost of doing business, on the basis that Thailand's symptoms are cost-push driven and not demand-pull stoked.

Policy-makers may opt to step up currency intervention to break the vicious cycle of the downward effects of purchasing-power parity.

The foreign-exchange market tends to shun currencies of countries with higher inflation because their purchasing power erodes faster than other currencies. For example, US headline inflation is 4.2 per cent, while Thailand's is 7.6 per cent. But the situation is like asking: "Which came first, the chicken or the egg?" Steering the baht into a strong direction will help bring down cost-push inflation as long it is supported by a favourable balance of payments.

Decelerating imports is anecdotal evidence that domestic demand is faltering and not a root cause of inflation. Intervening in the currency market will likely have more effect.

Selling dollars and buying baht is a form of monetary tightening. Such an exercise is a more optimal use of foreign-currency reserves than simply holding onto US treasuries, earning a lower yield than the cost of funding those foreign reserves.

The caveat is that sustained intervention may create a moral hazard, prompting people to be less cautious about spending, which could eventually end up being self-defeating.

Kobsidthi Silpachai is head of market and economic research at Kasikornbank's Capital Markets Division.