THE Bangko Sentral ng Pilipinas (BSP) decided to raise its policy rate by 25 bps to 6.50% during its Monetary Board meeting on Thursday. Likewise, the overnight deposit and lending facility rates were raised by the same magnitude.
Inflation in recent months has been driven mostly by supply side factors, especially constraints in the agriculture sector.
This being the case, supply side measures are the most appropriate solution to this problem. For instance, the surge in rice prices was the main reason for the higher inflation print in the past two months. The most effective solution to this is to increase the supply of rice either by importing more or by boosting local production, said Bank of the Philippines Islands in a market analysis released Oct. 27.
Nevertheless, the effectiveness of rate hikes in bringing down inflation shouldn’t be downplayed. Monetary policy continues to have a role in managing inflation even if the cause is mostly on the supply side. Inflation driven by supply may eventually lead to second round effects, which the BSP aims to counter with its rate hikes.
Governor Remolona said during the press briefing that monetary policy can serve to break the link between supply shocks and second round effects.
The BSP’s credibility as an inflation fighter is also another reason why another rate hike is necessary despite the fact that inflation is driven mostly by supply, the analysis said.
The rate hike is a statement from the BSP that it is determined to bring inflation back to its target. Inflation expectations may shoot up further if the market doesn’t see any action from the BSP. It might hurt the BSP’s credibility and make it more difficult to bring down inflation.
Despite the off-cycle hike, we can’t rule out another rate hike in the next policy meeting on November 16.
The decision of the BSP will depend on the upcoming data, as well as the behavior of the exchange rate.
An inflation print significantly higher than 6.1% might trigger another rate hike in that meeting. Aside from this, the central bank may also consider a rate hike if the exchange rate breaches the 57 level and moves closer to 58.
The economy has shown signs of strength and resilience despite the increase in interest rates. It should be noted that government underspending was the main reason why the economy slowed down in the 2nd quarter. It shaved off 1.3% from the 2nd quarter GDP growth, BPI said.
The economy would have grown by 5.5% if government spending did not contract. Certain indicators show that overall demand in the economy continues to be resilient. Credit card loans of the banking industry grew by 30.5% in August, which is faster compared to previous month.
The NPL ratio for credit cards also continues to be low at 3.8%, which means consumers have the ability to pay their obligations. Moreover, auto loans have rebounded, growing by 10.8% in August. The NPL ratio for auto loans has gone down to 7.5% despite the elevated interest rates, the media release said.
Local bond yields may stay elevated as the BSP continues to fight inflation, with additional upward pressure from the hawkish stance of the Federal Reserve, it said.
Depreciation pressure on the Peso may persist as market players weigh substantial imports, global financial market developments, and the central banks’ future policy move. The inflow of remittances during the holidays may offset some of the pressure on the local currency.
But the behavior of the local currency in 2023 may largely depend on what the Federal Reserve will do. Once the Fed is done hiking, the Peso may strengthen as markets will likely assess the possibility of rate cuts, BPI said.
If a recession in the US happens, the Fed may cut its rates and the BSP will likely follow. But in this situation, the appreciation of the local currency will likely be smaller compared to other currencies given the still substantial current account deficit of the Philippines this year and in 2024, it added. PR