THE Central Bank has moved into the money markets in an attempt to stop interest rates falling, but analysts are sceptical about the bank's ability in the long term to prevent a sharp drop in rates.
As the pound traded briefly under 102p against sterling yesterday for the first time in over a year, the Central Bank withdrew funds from the money market, effectively stopping rates from sliding too far. The key one month money market rate rose fractionally to 5% per cent following the Central Bank intervention.
"The bank has been trying to hold up one month rates and has succeeded so far," said Mr Padraic Garvey, an economist at Riada Stockbrokers.
The Central Bank is facing a dilemma in that it must choose between lower interest rates or a stronger pound. It is facing this dilemma because of recent heavy buying of Irish bonds by foreign investors.
Optimism that Ireland will qualify for EMU (Economic and Monetary Union) has prompted investors to pile into the bond market in the belief that interest rates will fall to German levels as monetary union approaches.
Overseas investors are believed to have bought more than £1.5 billion worth of Irish bonds in the past month.
The resulting huge flows of cash into the bond market will inevitably push interest rates down unless the pound is allowed to rise against sterling. Bond markets generally were boosted further yesterday by a surprise increase in US unemployment, which sent US bond prices soaring. Irish bonds - which have traded in enormous volumes in recent weeks - followed suit.
The Central Bank's problem is that it does not want the pound to rise, as this could mean a fall in the value of the money paid in EU intervention support to farmers. Recently, the bank has been selling pounds in an attempt to keep exchange rates low so as to prevent a revaluation of the "green pound" and a resulting cut in EU payments to farmers.
Mr Dermot O'Brien, chief economist at NCB Stockbrokers, said that a fall in money market rates this year seemed extremely likely. This would feed through to lower retail rates for both savers and borrowers. Irish Permanent has already cut some of its fixed rates.
"The Central Bank cannot both hold down the exchange rate and maintain current interest rate levels because demand for Irish pounds clearly exceeds supply at these levels," Mr O'Brien said.
However, if the money keeps flowing in, the bank will remain in a very difficult situation. Yesterday, top overseas economists were very vocal in their support of the Irish market.
Mr Steve Englander, international economist at Smith Barney in Paris, recommended that investors put their money into Ireland. "It looks like Irish interest rates are coming down over the next six months," he said.
Ms Phyllis Reed, European bond strategist at Smith Barney in London, agreed. "If you are going to be bullish, why not buy a market with a good chance of being in the first round of monetary union," she said. "Ireland is going to meet the Maastricht criteria."