The Monetary Policy Committee (MPC) on Wednesday announced a one percentage point increase in the policy rate to 13.5 per cent from 12.5 per cent.

It said upside risks to macro-economic stability as a result of the Euro zone debt crisis, fiscal pressures and the volatility in the foreign exchange market had led to the increase.

“In assessing the outlook for inflation, the Committee identified three main sources of upside risks to prevailing macro-economic stability. These are possible contagion from the Eurozone debt crisis, fiscal pressures and the unusual upward volatility in the foreign exchange market observed last month,” Mr Kwesi Amissah-Arthur, Governor of Bank of Ghana said at a press conference in Accra.

Mr Amissah-Arthur said with respect to developments in the Euro zone, the Committee was of the view that the potential impact of the crisis on the domestic economy could be transmitted through a reduction in trade finance to domestic banks, diminished portfolio inflows, worsening terms of trade due to reduced global demand for primary commodities, and reduction in remittances and donor flows.

He said while Government’s fiscal targets were met in 2011, potential sources of pressures exist in the outlook for this year.

“Specifically, the pace of executing the budget in terms of arrears clearance, including those relating to the migration to the SSSS, and the recently announced increase in the minimum wage may impose additional demand pressures,” the Governor said.

Mr Amissah-Arthur said there were concerns about the volatility of the cedi against major currencies as seen in recent weeks due to the rapid pace of imports in 2011 and the unusual surge in demand for foreign exchange during the last quarter of the year, which created a misalignment in Bank of Ghana’s foreign exchange cash flow.

“Initially, this led to a marginal depreciation in the interbank rate as banks searched for resources to meet their customers’ requirements. Further pressure was placed on the exchange rate when foreign investors sought early redemption of their investments on the domestic bond market,” he said, adding that the pass-through to inflation expectations of developments in the foreign exchange market was obvious.

He said Bank of Ghana would continue to monitor closely the performance of the cedi against the dollar and the other major currencies and take appropriate measures to stem potential threats to achieving the inflation target.

“The Committee concluded that the balance of risks to inflation is elevated. To contain future inflation pressures and realign interest rates in favour of domestic assets, it is necessary that monetary policy continues to be fine tuned to ensure that inflation expectations remain anchored to keep inflation within the target band,” Mr Amissah-Arthur said.

Therefore, the MPC has decided to increase the Monetary Policy Rate by 100 basis points to 13.5 per cent, he added.