Do Deteriorating Business Cycle Indicators and Tight Credit Conditions Affect the Repo Rate Adjustment to Positive Inflation Shock?

Abstract

Low growth and inflation at above the upper band of the target range continue to characterise the monetary policy landscape. In addition, forecast and business cycle indicators of economic activity indicate that growth will remain subdued and can slow down further. Labour market conditions have also deteriorated. With this in mind, we explore whether deteriorating business cycles indicators and tight credit conditions affect the repo rate adjustment to positive inflation shock.

Evidence shows that tight credit conditions shock; negative business cycle leading indicator (BCLI) and business cycle coincident indicator (BCCI) indicator shocks reduce inflation for long periods. For example, tight credit conditions and the negative leading indicators shock can lower inflation by 0.3 and 0.15 percentage points, respectively. The policy implications are that the repo rate response to inflation is slightly slower in the presence of tight credit conditions and subdued labour market and economic conditions.