The Bank’s focus was on the impact that VAT may have on inflationary expectations. Hence it was important to forestall the development of expectations of higher inflation by pointing out the dangers of accommodating second-round effects of VAT-related price increases and advising against possible compensatory wage increases. Higher interest rates were, therefore, aimed partly at ensuring that such expectations do not develop.
This was done in order to demonstrate the Bank’s commitment to containing inflation arising from any temporary VAT-related price increases, and in order that expectations of rising prices do not become entrenched. There was also a need for a tighter monetary policy given that credit growth was still higher than desired. The effect of the exchange rate on inflation was benign during 2002.