Credit Suisse expects inflation to reach a peak of 6% by Q4

MANILA, Philippines - Zurich-based Credit Suisse is not discounting the possibility that inflation could peak at six percent in the fourth quarter, and this could prompt the Bangko Sentral ng Pilipinas (BSP) to jack up interest rates by another 50 basis points before the end of the year.

In a research note titled “Philippine Economics: Monetary policy meeting — worried about capital inflows,” Credit Suisse analyst Devika Mehndiratta said consumer prices could breach the higher end of the BSP’s inflation target of three percent to five percent by touching six percent in the fourth quarter of the year.

“While we expect inflation to edge up, possibly even touching six percent in the fourth quarter, we do not see it reaching disturbingly high levels as was the case in 2008,” Mehndiratta stressed.

The analyst pointed out the BSP has historically been a bit on the cautious side while raising interest rates as it only raised policy rates in 2008 when headline inflation exceeded nine percent.

Latest data from the National Statistics Office (NSO) showed inflation hit a 26-month high of 4.6 percent in June based on 2000 prices and 5.2 percent based on 2006 prices.

Credit Suisse sees the BSP’s Monetary Board raising interest rates by another 50 basis points, bringing the overnight borrowing rate to 5.0 percent and the overnight lending rate to7.0 percent this year. It also expects the central bank to further raise the reserve requirement for banks and quasi-banks.

“While we see average 2011 inflation breaching the upper band of the BSP’s target range only slightly, at least for the sake of normalization if nothing else, we believe the central bank ought to adjust policy rates higher,” the investment bank said.

Mehndiratta said inflation risks continue to be tilted on the upside on the back of surging foreign capital inflows on the back of concerns on the downgrade of the triple A credit rating of the US due to the debt deadlock as well as the debt crisis in Europe particularly in Greece.

“Given that inflation risks are to the upside, we doubt it would want to be caught in a situation where there is a big unanticipated spike in inflation to handle in which it is then forced to effect sudden, large rate hikes,” Mehndiratta added.

The BSP raised interest rates by 25 basis points last March 24 and by another 25 basis points last May 5 as a preemptive move to keep inflation expectations well anchored amid escalating oil prices in the world market. This brought the overnight borrowing rate to 4.50 percent and the overnight lending rate to 6.50 percent.

Credit Suisse pointed out that the large amount of liquidity in the banking system including the P1.4 trillion special deposit accounts parked at the vault of the BSP woud reduce the effectiveness of any policy rate hike.

This prompted the central bank to also raise the reserve requirement for banks two times last June 16 and July 28 bringing the threshold to 21 percent from 19 percent to siphon off close to P70 billion in excess liquidity in the financial system as part of efforts to counter any additional inflationary pressures from excess liquidity.

Mehndiratta said foreign capital inflows would continue to increase as global uncertainties have somewhat increased over the recent months.

“It appears as if the fear of attracting too much in the way of foreign inflows was another factor playing on the central bank’s mind,” Mehndiratta added.

The BSP’s Monetary Board kept interest rates unchanged for two consecutive policy rate setting meetings last June 16 and July 28 but raised the reserve requirement for banks and quasi banks to curb additional inflationary pressures arising from excess liquidity in the financial system.