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The Bank of Thailand (BOT) is widely expected to raise its policy rate from a record-low of 0.5% during its August policy meeting. Thai policymakers have set themselves up for the start of the rate hiking cycle, following the dovish non-unanimous hold in the June meeting. The BOT has since then consistently signalled a gradual normalisation approach. This implies that the usual 25bps increase observed in the past has been fully priced into market expectations (also our baseline view). However, we think that there is a non-negligible risk that the BOT might be debating bigger moves, especially given the context of multi-year high inflation and hawkish surprises by Asian central banks. We consider this aggressive risk scenario in this report.

Big unexpected hikes seen in 2005

Looking at BOT’s policy rate decision history, hikes exceeding 25bps in a single meeting were rare, but occurred in two occasions. The BOT surprised twice with big increases of 50bps each in September and October 2005, raising the policy rate to 3.75%, before tapering to five more 25bps increases. 

The two surprise 50bps hikes in 2005 stemmed from the BOT’s concern from accelerating inflation that reached a multi-year high. The pick-up in Thai inflation in 2005 was driven by the removal of domestic retail oil subsidy to align local prices to rising global oil prices, which led to second-round effects.

The ongoing increase in headline inflation to almost 8% YoY in June 2022 (above BOT’s 1-3% inflation target range) has been also majorly driven by rising global energy prices. The difference, however, comes from efforts to curb the passthrough to domestic prices via subsidies, to support purchasing power amid a nascent recovery from the pandemic. The take-off in core inflation so far has been due to normalising economic conditions from the pandemic, rather than second-round effects and strong demand-pull pressures. Policymakers remain watchful of broadening price pressures. A case can be made for the BOT to adopt large and forceful outsized rate hikes from the perspective to firmly anchor inflation expectations, ensure medium-term price stability, and to avoid falling behind the curve. With the real policy rate standing at ~-3% in June (~-1% in 2005), monetary policy is extremely accommodative. Moreover, external spill-overs from an aggressively hawkish US Federal Reserve, resulting in a depreciating Thai baht vs the US dollar, could pose upside risks to imported inflation. A sizeable rate increase would reduce the policy interest rate gap between Thailand and the US.

Growth recovery on track

Concerns surrounding an uneven Thai economic recovery from the pandemic are keeping policymakers cautious in monetary policy normalisation, even as they acknowledged inflation threats and a less needed very accommodative monetary policy.

During the 2005 surprise hikes, the Thai economy was arguably in a better situation than currently, expanding by more than 4% YoY. The global landscape also looked stronger and less uncertain, despite a soft patch. However, the BOT’s forward-looking assessment that the Thai economic recovery will continue to gain traction over the course of 2022 and return to pre-pandemic trend growth could allow it to undertake bigger hikes to quell inflation. Real GDP growth is seeing upside momentum, having bottomed out in 3Q21. The ongoing Thai growth recovery is largely dependent on the crucial tourism sector. It is finally on a recovery path, even if a complete recuperation to pre-pandemic levels is still far away.

Financial stability from interest rate increases

Financial stability questions regarding the ability of Thailand households and businesses to cope with interest rate increases are surfacing. First, Thai households should have the ability to deal with outsized interest rate shocks. A relatively larger share of Thai household debt is fixed interest rate-related (60%), despite fragility from an elevated household debt of ~90% of GDP as of 1Q22.

Second, however, Thai businesses are more exposed than households. About 60% of business loans are floating even though outstanding debt is slightly lower as a share of GDP. We think the BOT’s main concern would be on small and medium enterprises (SMEs). Big interest rate adjustments, if adopted, might exacerbate this weakness, warranting targeted support.

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