KARACHI, Sept 15: The State Bank on Wednesday signalled that it would not mind increasing the interest rates aggressively if inflation continued to rise at an undesirably high pace. The central bank did so by raising the weighted average yield on six-month treasury bills by 38 basis points to three per cent.

The central bank increased the average yield on the six-month paper from 2.62 per cent to three per cent and managed to sell Rs1.1 billion worth of bills at this rate. The fact that this is the biggest rise in T-bills rate after a long time and that it has been made to give a direction to the market -- and not just to borrow funds -- makes it clear that the SBP is stepping up efforts to check inflation.

Marginal consumer inflation shot up by 9.33 per cent in July and 9.25 per cent in August 2004, alarming economic managers who have projected five per cent consumer inflation for full fiscal year ending in June 2005.

The Asian Development Bank and the International Monetary Fund have recently conveyed to the government that inflation seems set to fly past the targeted level for a host of factors, including booming oil prices.

An above nine per cent marginal inflation in the first two months also indicates that average inflation during this fiscal year will rise far beyond the targeted level if the policy-makers do not intensify efforts to check it.

That is why the central bank, which started a gradual hiking of T-bills rate far back in February 2004, let the yield shoot up by 38bps in one go on Wednesday. And, since it sold the bills on Wednesday without any real need for generating funds for the government, and amidst tight liquidity, makes it clear that the SBP just wanted to send a signal to the market.

The SBP had called the T-bills auction against no maturity of previously sold bills and had set a nominal sale target of Rs2 billion. Senior bankers said the auction generated Rs5.7 billion bids of which the SBP accepted Rs1.1 billion and rejected the rest.

The central bank in its monetary policy for July-December 2004, announced in the third week of July, had said that it would tighten the policy to check inflation. But, as in the previous months, the SBP made measured and gradual hiking of T-bills rates instead of letting them rise sharply. This, at times also annoyed banks that were looking for a bigger rise.

REFINANCE RATE: Export refinance rate is tied up with the yield on six-month T-bills rate. For September 2004, the export refinance rate was 2.5 per cent, which means banks can lend to eligible exporters at a maximum rate of four per cent, keeping a 1.5 per cent spread allowed by the SBP. The export refinance rate for October now looks set to rise to three per cent.