KARACHI, July 7: The State Bank on Wednesday raised the cut-off yields on three-month and one-year treasury bills by 30 basis points and 45 basis points respectively. The central bank did this at an auction held for selling treasury bills. This sets the stage for a gradual hiking of interest rates during this fiscal year.

The State Bank sold Rs64.95 billion three-month bills at a cut-off yield of 2.05 per cent up from the last cut-off yield of 1.75 per cent in May. It also sold Rs550 million one-year bills at a cut-off yield of about 2.70 per cent up from 2.25 per cent in May.

In total, the State Bank sold Rs65.5 billion treasury bills against the target of Rs60 billion. Senior bankers say a 30bps and 45bps increase in the yields on three-month and one-year bills indicates that the central bank is setting the stage for gradual hiking of interest rates during this fiscal year.

The SBP said in its third quarterly report for the outgoing fiscal year that it had raised interest rates somewhat in April and May 2004 to temper inflationary tendencies.

It also said that it was ready to move promptly to stave off inflationary pressures when required, meaning that it would gradually raise interest rates, if needed. CPI inflation or inflation measured by Consumer Price Index shot up to 7.13 per cent year-on-year in May 2004 and average CPI inflation in eleven months to May 2004 rose to 4.22 per cent over the same period of the last fiscal year. SBP is anticipating 4.5- 4.6 per cent inflation for July/June 2003/04, data for which will be out shortly.

The Wednesday's increase in the cut-off yields of three-month and one-year treasury bills is the first one of the new fiscal year. It is also the first increase in T-bills yields after the US Federal Reserves hiked its benchmark federal funds rate on June 30 by 25bps to 1.25 per cent, after a long interval of four years to contain inflation.

Last month the State Bank had to scrap a regular auction of three-month and one-year treasury bills because the banks had demanded 88-176bps and 91-230bps rise in weighted average yields.

Allowing such a big rise in the T-bills yields was out of the question because SBP was in favour of hiking the yields gradually and by lower margins to avoid volatility in interest rates to keep rising economy on track.

Earlier in May 2004, the SBP had sent this signal by raising the cut-off yield on six-month T-bills by 39bps to 2.23 per cent. This increase pushed up export refinance rate, for the first time in ten months, by 50bps to 2 per cent in June 2004. The same rate is valid for this month.

But if the central bank raises the yield on six-month bills in the next auction, due later this month, export refinance rate would also move up. With the refinance rate at 2 per cent, banks now offer export finance to eligible exporters at 3.5 per cent. Any hike in export refinance rate would make export loans dearer accordingly.