- Increase in interest rates

The Central Bank of Malta increased the central intervention rate by 25 basis points to 4.25% during the Monetary Policy Advisory Council meeting held on 30 May 2007.

The Governor of the Central Bank of Malta considered that against the background of a further narrowing of interest rate differentials and reductions in the external reserves, the prevailing central intervention rate no longer provided adequate support to the exchange rate. The short-term interest rate premium on the Maltese lira fell in May to its lowest level since the entry of the lira in ERM II, as euro interest rates rose faster than comparable rates in Malta amid growing expectations of continued monetary policy tightening in the euro area. Reflecting upward pressures in the domestic money market, the primary market rate for three-month Treasury bills continued to rise. In the capital market, investors were liquidating Maltese lira assets, suggesting that these were not offering an adequate interest rate differential over their euro counterparts. Meanwhile, the underlying downward trend in the Bank’s external reserves continued into May, again partly under the impact of the conversion of Maltese lira holdings into euro and the retention of euro-denominated earnings. As in previous months, the decline in the reserves was accompanied by a further contraction in the amount of currency notes in circulation.

In its deliberations, the Council noted the first quarter improvement in export performance and the further drop in unemployment against the background of falling inflation. While acknowledging these positive developments, the Governor recalled that in a fixed exchange rate regime, the primary focus of monetary policy was the stability of the currency. He also pointed out that, following this latest increase, official interest rates were still below the peak level reached in 2000.

Referring to the favourable conclusions of the recently published Convergence Reports of the European Commission and the European Central Bank, the Governor stressed that until the euro adoption date, the Bank will continue to use its monetary policy instruments to keep the Maltese lira stable in ERM II and thus ensure a smooth transition to the euro. He reiterated that there was no advantage to be gained by converting domestic assets into euro before the changeover date.

The Monetary Policy Advisory Council is due to meet again on 28 June 2007.

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