KARACHI, June 8: Expectations are building up for an immediate hike in interest rates but the State Bank wants to dampen it to ensure that no abrupt changes creep into interest rate structure.

That banks are fuelling these expectations is evident from the fact that on Tuesday they demanded a big increase in the treasury bills yields. They asked for 88-176 basis points and 91-230bps increase in the existing weighted average yields on three-month and one-year bills at a regular auction held for the sale of treasuries of the two tenures.

So widespread was the anticipation for a hike in treasury bills yield on Tuesday that almost all major local and foreign banks demanded a much higher than existing yield on three-month and one-year bills.

The list included such big names as (i) National Bank (ii) Habib Bank (iii) UBL (iv) Citibank and (v) ABN Amro. The banks came up with Rs25.75 billion bids for three-month and one-year bills in total against the auction target of Rs15 billion.

They priced their bids for three-month bills between 2.58-3.46 per cent against the existing weighted average yield of 1.70 per cent. Similarly the bids for one-year bills were priced at 3.10-4.49 per cent against the existing average yield of 2.19 per cent.

The State Bank rejected all bids without assigning any reason. But SBP sources said the central bank did it to avoid hiking the T-bills yields because that could have sent a wrong signal to the market.

Between February-May 2004 the SBP allowed the weighted average yield on three-month and one-year bills to rise by 22bps and 23bps to 1.70 and 2.19 per cent respectively.

During the same period it also allowed 43bps increase in the average yield on six-month treasury bills that currently stand at 2.07 per cent. The reason for allowing this hike in the T-bills yield was to send signals that interest rates were set to inch up after falling to historic lows.

Allowing a gradual hike in the interest rate had become inevitable to dampen inflationary expectations and keep inflation in check. CPI inflation shot up to 6 per cent and SPI inflation to 8.4 per cent in April 2004 year-on-year.

In ten months to April CPI and SPI inflation also rose by 3.93 per cent and 8.4 per cent YoY as the economy grew faster than expected. The economic managers say GDP growth during this fiscal year ending in June may reach 6 per cent against the initial target of 5.3 per cent.

They cite it as a reason for higher than target increase in CPI inflation. The initial target for CPI inflation for this fiscal year was set at 3.9 per cent but indications are that it would reach 4.5 per cent.

Senior bankers say the reason why banks demanded higher than existing average yields on treasury bills on Tuesday was that they were anticipating that the central bank would have to let the yields rise further.

They say hiking the interest rates has become inevitable because SBP is determined to keep inflation below 4.2 per cent and it also needs to rein in a faster than targeted growth in monetary assets.

Monetary assets or M2 grew by 15.4 per cent in eleven and a half months of this fiscal year against the full year target of 11.06 per cent. Bankers also took clue for further interest rate hike from the increase allowed by the State Bank in the weighted average yields on long-term Pakistan Investment Bonds.