The Bank of Jamaica (BOJ) will lower the policy interest rate by 25 basis points to 1.5% effective today (March 1). The BOJ forecasts that core inflation is likely to be between the target band of 4% to 6% within the medium term, and this action is expected to facilitate the BOJ in meeting this target sooner. The interest rate cut is to be complemented by a 3% reduction in the cash reserve requirement for deposit taking institutions such as banks. A decrease in the cash reserve ratio means that banks are required to keep a smaller amount of cash, which frees up more money to be lent to businesses and individuals. This action is expected to release J$16.8B into the local market to further enable institutions to provide more credit at lower interest rates and on better terms. The BOJ has stated that the decision is not aimed at influencing the exchange rate, but rather to increase private sector credit.
What does this mean?
Simply put, interest rates are the price of money. When interest rates decrease, the supply of money is higher which typically translates into higher levels of investment by businesses and greater spending by consumers. Many transactions across the economy ranging from financing real estate projects, purchasing raw material for a factory or even buying a meal are in some way funded by credit. When businesses and individuals can finance their goals at a lower cost, because the price of money is lower, it improves the feasibility of entrepreneurial activities in the economy. As a result, a business can hire more staff, expand their facilities and take on more ambitious projects which opens the door for increased economic output. When more dollars chase the same amount of goods, prices increase which is called demand push inflation. The BOJ, through its “inflation targeting” approach is aimed at boosting demand push inflation which is a key component in increasing economic growth.
Recommendations and Outlook
Since 2015, interest rates have been trending downward by more than 20% according to BOJ data. Also, since 2015, the level of local real estate development has increased significantly, and the Jamaica Stock Exchange has been quoted as number one in the World for that year and 2018 by Bloomberg. We expect that the increase in money supply will continue to influence credit expansion in the real economy for the rest of 2019. Interest bearing investments such as bonds and money market investments have lower yields than five years ago as opposed to non-interest-bearing assets such as stocks, real estate, pooled investments vehicles and private equity investments. In this investment climate, investors should still seek to keep a diversified portfolio, but may generate better returns with increased exposure to real assets and equity.