BSP seen to maintain rates as inflation eases

MANILA, Philippines - London-based Barclays Capital and American banking giant Citigroup said the lower-than-expected inflation registered in May could further delay the possible hike in key policy rates by the Monetary Board of the Bangko Sentral ng Pilipinas (BSP).

Barclays Capital economist Prakriti Sofat said in a research note that the easing of inflation to 4.3 percent in May from 4.4 percent in April and the stronger-than expected gross domestic product (GDP) growth of 7.3 percent in the first quarter of the year could push the 25-basis-point hike in key policy rates by the Monetary Board to the third quarter of the year.

“We believe the strong turnaround in economic momentum will result in the output gap closing by the middle of the year, which will feed into core inflation. Overall, we expect price pressures to continue to rise gradually and the central bank to start normalizing rates in the third quarter with a 25-basis-point hike,” Sofat stressed. 

She pointed out that the US Federal Reserve Board is also expected to start jacking up its key policy rates by the third quarter of the year.

“However, we believe the risks that rate normalization gets pushed back have increased. Key factors to watch are movements in commodity prices, especially oil, and continued concerns about global growth on account of developments in Europe,” she added .

The Barclays economist explained that the risks on its inflation forecasts are biased towards the downside as long as commodity prices remain at current levels.

For his part, Citi economist Jun Trinidad said the lower-than-expected consumer price index (CPI) in May indicated a benign inflation path over the next 12 months with inflation hitting a high of 4.5 percent between July and August instead of 5.0 percent or more.

“May CPI may have been a turning point. We think the May CPI stats represent a turning point for inflation moving forward. Our updated extrapolation of the monthly CPI series that included better than expected May CPI indicated a benign baseline path over the next 12 months in which the new high would be 4.5 percent year-on-year in July to August instead of 5 percent or more, followed by a correction later in the year to 3.2 percent by December,” Trinidad said.

He pointed out that benign inflation gave monetary authorities more flexibility in maintaining its accommodative policy stance and to keep its key policy rates unchanged until the end of the year.

The BSP has set an inflation target of 3.5 percent to 5.5 percent this year and 3.0 percent to 5.0 percent for next year. However, the Monetary Board also decided to lower its inflation forecast to 4.7 percent instead of 5.1 percent this year and to 3.6 percent instead of 3.7 percent next year on the back of lower oil prices as well as cheaper power and water rates.

“The revisions imply policymakers’ flexibility to extend its accommodative stance. There’s downside risk to our fiscal year 2011 inflation forecast exceeding 5.0 percent that supported our view of rate normalization beginning end-December 2010,” Trinidad added. 

He pointed out that the statistical trend in the inflation series suggests a decelerating pace of inflation for much of the second half of the year unless some exogenous demand or supply shock materializes in the succeeding months.

Last Thursday, the BSP decided to keep its key rates at record low for eight consecutive policy-setting meetings since July last year amid the ongoing debt turmoil in Europe, the growing tension between North and South Korea, and the stronger-than-expected GDP growth in the first quarter of the year.

The overnight borrowing rate was kept at a record low of 4.0 percent and the overnight lending rate was maintained at 6.0 percent.

Apart from keeping its key policy rates unchanged, the BSP also decided to put on hold further withdrawal of liquidity enhancing measures.

Last Jan. 28, monetary authorities started to phase out liquidity enhancing measures that were implemented way back in November 2008 in light of the gradual global economic recovery

Crisis-related measures that were tweaked included the increase in the rate on a short-term lending facility to four percent from 3.5 percent as well as the reduction of the peso rediscounting budget to P40 billion and further to pre-crisis level of P20 billion from P60 billion, the restoration of the loan value of all eligible rediscounting papers to 80 percent from 90 percent of the borrowing bank’s credit instrument, and the restoration of the non-performing loan (NPL) ratio requirement of two percentage points from 10 percentage points.