Bond yields dropped by nearly .5 percent at auctions a day later.
Market analysts were however surprised by the sudden swing of yields.
Monetary Policy has rarely been so loose. Low rates have helped boost credit demand and economic growth. But they can also push prices up.
The rate of prices rises in the last two months has been higher than the rate a year ago.
But this inflation is not entirely a cause of loose monetary policy of the Central Bank.
Higher commodity prices and a weak rupee contributed greatly. What ever the reason, Central Banks that like price stability, get worried when inflation suddenly picks up.
Modern Central Banks also prefer to target inflation instead of the money supply to maintain price stability.
So last month's point-to-point Inflation hitting double digits according to the CCPI would have got the due notice of the monetary authority.
Even more significant would have been the upward trend in all price indices.
Most Central Banks would get ready to raise interest rates to give savers real returns and stem inflationary pressures.
Although there is no reason for panic, bond traders are keeping a close eye on inflation numbers and Central Bank statements.
But bond traders say interest rates are doing the unbelievable by heading in the opposite direction to inflation when nothing has take place to significantly alter the macro economic outlook.
National Savings Bank (NSB), the Bank of Ceylon (BoC), People’s Bank (PB) and the state managed pension funds the EPF and ETF have been driving bill and bond yields lower.
Yields fell nearly 20 basis points for three month bills driving down rates in the secondary market too.
Bond yields did a similar dive in the primary auctions a day later.
Market players who put in low bids at primary auctions said they bid on market fundamentals. Traders said around 90 percent of bills and bonds in this week's auction were snapped up by State institutions who submitted the lowest bids.
The Public Debt Department of the Central Bank which issues debt on behalf of the government accepts the lowest bids to minimize the interest cost.
But for pension funds like the EPF and the ETF that focus on giving the best possible returns to their members low yielding bonds are not the most attractive.
The superintendent of the EPF however told LBR that they have very few investment options besides government securities and can't lose out on the options even if it means lowering the yields.
But the apparent synchrony of state sector players in the bond market left other traders surprised!
Their actions single-handedly helped drive down interest rates.
Economists said interest rates were being administered by the government instead of allowing them to be market determined.
Not that low interest rates are bad.
Infact, low and steady interest rates encourage economic growth by making cheap credit available and giving business the confidence to make long term plans.
But the benefit of using pension funds and state bank deposits for this is questionable, if it means employees don't get the best possible returns.
This is also why state involvement in business is not always in the interest of citizens.
However, private sector primary dealers are not complaining.
Their bond portfolios, marked-to-market, are now worth more, so why should they mind?
But long term effects of state meddling in capital markets can be bad.
Not only will it discourage the private sector, but will also undermine established market mechanisms.
The government is heading in that direction.
Recently, the Finance Ministry issued circular reminding ministries, public corporations and government owned companies that money should not be invested through non-state primary dealers or brokers with out approval.
The Finance Act of 1971 under which the circular was issued was not strictly implemented until the circular came out in July this year.
Limiting options for government entities limits price transparency and discourages markets.
Efficient markets ultimately benefit everybody by achieving price transparency.
Administering markets using public money from bank deposits and pension fund contributions is also unjust by unsuspecting depositors and pension fund contributors.
It is an extra tax on them.
But it is easy to manipulate the small markets here, where nearly half the financial sector assets are under state control.
Primary dealers who are the market makers for government debt, only control 2.3 percent of financial sector assets, no match for any concerted effort by state institutions to administer interest rates.
Economists wonder if these are the first signs of a move towards interventionist Keynesian economic management and an abandoning of market friendly monetarist policies.
A sure sign that low rates are not sustainable.
-LBR Newsdesk: LBOEmail@vanguardlanka.com