- Decrease in interest rates

During the Monetary Policy Advisory Council (MPAC) meeting held on 28 December the Governor of the Central Bank of Malta reduced the central intervention rate by 25 basis points to 4.00%.

The Governor explained that the reduction in the central intervention rate completes the process of convergence of official interest rates in Malta with those of the euro area. He recalled that under Malta’s existing fixed exchange rate regime, the central intervention rate embodied a premium to compensate investors for exchange rate risk. With the adoption of the euro on 1 January 2008, this risk and the consequent premium on official short-term interest rates will disappear. Hence, at its new level of 4% the central intervention rate is identical to the minimum bid rate on the main refinancing operations set by the European Central Bank (ECB). The Governor expected the latter rate to serve as the benchmark interest rate in Malta once the euro becomes the national currency, influencing domestic money market rates as well as bank deposit and lending rates. The overnight deposit and lending rates set by the Central Bank of Malta, which are currently linked to the central intervention rate, will also be replaced by the respective interest rates set by the ECB on similar instruments, that is the overnight deposit facility and the marginal lending facility.

The Governor further recalled that on 1 January 2008, the Central Bank of Malta will become a member of the Eurosystem, which comprises the ECB and the national central banks of the EU Member States that have adopted the euro. The Eurosystem, through the Governing Council of the ECB, is responsible for formulating and implementing monetary policy in the euro area, with the primary objective of maintaining price stability. As from that date, the Governor of the Central Bank of Malta will participate in the deliberations of the Governing Council as a full member. At the same time, the Bank will become responsible for the implementation in Malta of the ECB’s monetary policy stance.

The Governor noted that as a consequence, the MPAC will be dissolved as of 31 December 2007. While thanking current and former Council members for their contribution to the formulation of monetary policy over the years, he announced that new structures have been set up within the Bank to support his participation in the Governing Council and to receive reports from him on decisions taken by the Council.

During the MPAC meeting, the Council noted that the Central Bank of Malta’s net foreign assets declined in December as the Bank continued to be a net seller of foreign exchange to credit institutions, with seasonal demand being reinforced by the continued conversion of Maltese lira holdings into euro. The short-term premium on the Maltese lira increased during the month, while the long-term interest rate differential remained broadly unchanged.

In its review of recent economic data, the Council noted evidence of continued strong growth, as seen in the GDP data for the third quarter. However, the Council also observed that inflation accelerated further against a backdrop of rising global prices of key commodities, particularly food and oil, which were also adversely affecting the trade balance. The Governor warned that in the context of upside risks to inflation and downside risks to global growth, and given Malta’s participation in a monetary union, it is even more important to ensure that fiscal policy continues to support macroeconomic stability, that wage developments remain in line with productivity growth and that further productivity-enhancing structural reforms be introduced to safeguard the international competitiveness of the Maltese economy.

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