Treasury Outlook: Short-term rates to stay low

Long-term interest rates, such as government yield curves, have been gradually increasing, while short-term interest rates have remained stable or even declined in some markets.

There are several explanations behind this apparent paradox, which may assist us with the rate outlook for next year.

It has been almost a year now since all central banks around the world kept their policy rates at an extraordinarily low level. During that time, other interest rates remained low as well until the recent move by the Reserve Bank of Australia, which surprised the market by increasing its policy rate by 50 basis points in the space of four weeks.

Markets have now become more cautious, compared with the previous several months, pondering whether other central banks would follow the RBA's course.

The move by the RBA also created a new theme in financial markets as many analysts are now adding increasing interest rate trends into their analyses, which currently feature a combination of economic recovery and fiscal deficits.

We now have three factors which, mostly people believe, have caused long-term interest rates to rise. First, Thai local interest rates have been impacted by global rate movements causing them to rise as well.

Second the rise in supply from the government may also be one of many catalysts driving our market. In this budget year, which started last month and will end next September, the government is expected to issue government bonds worth Bt500 billion, excluding roll-overs - an almost 20-per-cent increase from the previous budget year. Those amounts of debt will finance budget deficits together with investment under the SP2 programme.

Third on the list, reflecting recent interest rate trends, are inflation fears. According to figures released earlier this month, headline inflation moved up 0.4 per cent year-on-year, the first positive number in seven months.

The more interesting part is the bullish tone set by the Bank of Thailand in its latest inflation report. The central bank raised its outlook for economic growth and also core inflation forecasts for next year. The highest inflation period next year is expected to be in the first quarter, which is a little bit earlier than the market had expected. These factors combined have exerted more pressure on interest rate expectations and resulted in the recent rise in long-term rates that we anticipated.

However, the short-term interest rate market is a totally different story, with local short-term rates remaining stable for quite sometime. The major reason for this despite the rise in other rates mentioned earlier is the ample liquidity in the banking system.

Currently, we have more than Bt1 trillion in the repo market, half of which is considered excess liquidity. The current account surplus is the major cause of this excess liquidity.

The central bank has forecast that Thailand will record a current account surplus of as much as US$21-24 billion (equal to Bt700-800 billion) in 2009, and an additional US$6-9 billion (Bt200-300 billion) in 2010.

With this amount of current account surplus, if true, the surplus liquidity will still be there. Only two things might decrease liquidity - a significant increase in private investment and current account deficits, which are unlikely to be the case for 2009 or 2010.

We believe that short-term interest rates will stay at this low level for quite sometime until there is a significant shift in policy stance, which is expected to be seen in the second half of next year.