Cyprus bank keeps rates unchanged at 4.5 pct, despite fears of economy overheating

NICOSIA (Reuters) – Cyprus’s central bank kept interest rates unchanged yesterday, even though an acceleration in inflation and record credit growth pointed to an overheating economy. Less than three months before adoption of the euro on January 1, 2008, the key refinancing rate remained at 4.5 percent, 50 basis points above the euro equivalent. The island’s central bank left the Lombard rate at 5 percent and its overnight deposit facility rate at 3 percent, its governor, Athanassios Orphanides, told reporters. «Inflationary pressures continue to be fueled by high oil prices and some food categories as well as the rapid expansion registered in money supply and loans to the private sector,» he said. Credit to the private sector was contributing to high real estate prices and a widening of the trade deficit and was a cause of concern, Orphanides said. Official figures show consumer inflation in September was running at an annual 2.63 percent, while credit to the private sector was up 24.2 percent in August. Orphanides said robust credit expansion was fueling inflationary pressures. «Our economy is overheating and this will lead in the next few months to further inflationary pressures,» he said. The governor urged the government, which faces elections in February 2008, to be prudent with fiscal policy. «With our euro area accession, our ability to keep inflation at bay with monetary policy will be reduced and we need to be assisted by fiscal policy in the short run,» he said. Orphanides also expressed concern over possible wage increases above the rise in productivity. «We could live with an inflation rate of 2.6 percent. One of the worst-case scenarios is to see excessive wage increases. This would create inflationary pressures for the next two, three or four years and will continue to accompany us,» he said. Orphanides said that with the Cyprus pound being phased out, it would make no sense to raise interest rates at this stage to combat inflation. «It would be good for the Cyprus economy to have higher rates (under different circumstances).» Orphanides said.

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