Premium on Maltese lira short-term interest rates lowest since entry in ERM II

The Central Bank of Malta has published the second issue of its Quarterly Review for 2007, which analyses economic and financial developments both in Malta and abroad since the beginning of 2007, with an emphasis on the first quarter.

The review notes that the bank tightened its monetary policy stance further in May, raising the central intervention rate by another quarter of a percentage point to 4.25%. This decision was taken in the light of narrowing interest rate differentials and a downward trend in the bank's external reserves.

The bank emphasised that, until the adoption of the euro on January 1, 2008, it remains committed to ensuring that domestic financial conditions were supportive of the central parity rate of Lm/€0.4293 within ERM II.

Money market rates generally moved in line with movements in official rates. The domestic three-month Treasury bill rate rose in the first half of 2007, but in overseas markets the comparable euro area rate increased more rapidly.

Thus, the premium on Maltese lira short-term interest rates reached its lowest level in May since the entry of the lira in ERM II. In June, however, the premium widened slightly following the May increase in the central intervention rate.

The review observes that broad money continued to expand at a steady pace, despite a further decline in currency in circulation. Monetary growth was driven by a rise in domestic credit, but was dampened by a contraction in the net foreign assets of the banking system.

The bank's net foreign assets extended their downward trend, reflecting the impact of a number of factors, including the premature conversion of domestic currency holdings into euros in anticipation of euro adoption, the retention of euro-denominated earnings by exporters and lower receipts of EU funds.

Turning to the real economy, the review notes that in the first quarter of 2007 the Maltese economy expanded by 3.5% on a year earlier, up from 3.1% in the previous three-month period. Growth was generated mainly by higher net foreign demand, as exports rose while imports declined.

Consumption also had a positive impact on growth, even though it expanded at a slower pace. On the other hand, gross fixed capital formation declined.

Inflation continued to fall, with the 12-month moving average rate based on the HICP dropping to 2.2% by March. The easing of price pressures was due to the unwinding of the impact of earlier increases in energy prices, downward pressure from accommodation prices and generally low inflation in the other HICP components.

Meanwhile, the unemployment rate based on the Labour Force Survey remained below 7% in the first quarter, practically unchanged since the second half of 2006, and lower than a year earlier. The shift in employment from the public to the private sector continued. Full-time positions accounted for most of the jobs created.

The bank's new business survey, which focuses primarily on developments in the services sector, was carried out between May and June. The initial results indicate that second-quarter profits and turnover were both higher than in the first quarter. These patterns are expected to persist in the following quarter.

On the balance of payments, the review comments that during the March quarter the deficit on the current account narrowed on a year earlier. This was entirely attributable to a smaller merchandise trade gap, which outweighed lower surpluses on services and current transfers, as well as a wider deficit on factor incomes. After excluding movements in official reserves, net inflows on the capital and financial account declined.

Foreign exchange conditions in the local market continued to be characterised by a stable euro/Maltese lira exchange rate. The lira maintained its ERM II parity rate of Lm0.4293 against the euro throughout the first quarter. Moving in tandem with the euro, the lira strengthened further against the US dollar, the Japanese yen and the pound sterling.

In its analysis of fiscal developments, the review reports that during the first three months of 2007 the general government deficit fell over a year earlier as revenue grew faster than expenditure. General government debt also contracted during the year to March.

This issue of the Quarterly Review is available on the Central Bank of Malta Website, www.centralbankmalta.com.