The Bangko Sentral ng Pilipinas (BSP) is preparing the public for more sharp inflation increases, a possible benchmark rate of 3.5 percent by end-2022, and an exchange rate at P54-P55:$1 in the next months due to supply shocks and the unpredictability of the Ukraine war.
Market analysts are aware of this and expects inflation that run up to a 43-month high of 6.1 percent in June versus 5.4 percent in May, will not likely to stop from escalating further and could settle at an average of 5.5 percent, higher than the BSP’s 2022 average rate forecast of five percent.
HSBC economist for ASEAN, Aris Dacanay, said on Tuesday, July 5, that inflation in the next months may continue to increase – “but the decision to hike rates more aggressively will depend on GDP growth and the exchange rate.”
“A few minutes prior the CPI (consumer price index) release, the new BSP Governor signalled that the policy rate may be as high as 3.50% (percent) by year-end (Bloomberg July 5), which is in line with HSBC forecasts,” said Dacanay.
The strong US dollar has caused the peso to sharply depreciate last month and fell to P53 on June 10, P54 on June 17, and then again to a 17-year low of P55 last June 29. HSBC forecasts the exchange rate to “drift to 55.5 by the end of 3Q 2022 (third quarter).”
BSP Governor Felipe M. Medalla, in his first formal address to the BSP population as its new chief, said that given the size of the global supply shocks and geopolitical uncertainties, it has become increasingly challenging to put a lid on price pressures. With headwinds plaguing the economy and central banks’ normalization policies across the globe, he said the BSP needs to stay focus, and “keep our pencils sharp (and) our ears closer to the ground.”
“It will take more than a few months, many months, before the headline inflation, which is reported monthly by the PSA (Philippine Statistics Authority), to go down below four percent,” said Medalla.
The increase in the US interest rates of 75 basis points (bps) last June 16 is complicating BSP’s targeting abilities. On June 23, the BSP mirrored the rate hike, but only by 25 bps, bringing the current policy rate to 2.5 percent.
“The recent large policy rate hikes of the Fed in reaction to, what most would consider to be, unanticipated, meaning wrongly forecasted, US inflation spike is causing nearly all currencies to significantly depreciate against the US dollar. This is certainly adding another layer of complication to our domestic inflation targeting and expectations,” according to Medalla.
He also said that the ongoing policy normalization, which could result in tighter global financial conditions, increased financial market volatility, and capital flow rebalancing across the globe, will be “bringing with it heightened volatility in our foreign exchange rates and capital markets.” The peso on June 29 broke past the P55:$1 level for the first time since 2005. On Tuesday, the peso lost more ground at P55.23 versus P55.08 on Monday.
“This year, sad to say, the average inflation will, in all likelihood, breach the National Government’s target of 2-4 percent by quite a bit. Our current runs show that average inflation will remain elevated,” said Medalla.
Still, he said he is confident that the central bank will continue to have ample policy space, given that the banking system is well-capitalized and the country’s US dollar reserves are considered “robust” enough to protect the local currency amid rising inflation and benchmark rates.
Meantime, Bank of the Philippine Islands (BPI) in an inflation commentary on Tuesday, said that with inflationary pressures building up due to high oil prices and weak peso which pushed the inflation rate past six-percent level in June, they expect the peak to arrive in October. “In this scenario, average inflation is expected to settle between 5 to 5.5% (percent),” said BPI.
BPI analysts said at this rate, the BSP is expected to adjust rates higher until end-2022. There are still four scheduled Monetary Board policy meetings this year, the next one is on Aug. 18.
“With inflation still on the rise, we continue to expect rate hikes from the BSP until the end of the year. Assuming the central bank will continue to hike gradually, the pressure on the peso will remain substantial since faster rate hikes in the US will make the dollar more attractive,” said BPI. It added that “hiking the policy rate by 50 bps now rather than later may help in mitigating the risk of bigger hikes in the future that could cause more volatility in the markets.”
As for the exchange rate, BPI said the peso will continue to depreciate in the medim term as imports increase with the expanding economy. “Dollar demand may pick up and keep the exchange rate above the 54 level. Meanwhile, the possibility of tighter dollar supply may contribute further to peso depreciation,” it added, with an aggressive US Federal Reserve.
HSBC’s Dacabay commented that with the sharp peso depreciation last month could place upward pressure on domestic prices throughout July, especially with the increase in transport fares which took effect this month. This will add about 0.6-0.7 percentage point to inflation, he said.
“With inflation still likely to increase, does this warrant the BSP to hike rates more aggressively? As a net importer of goods, it seems managing the currency can also help manage inflation. But, with the BSP signalling that it may increase the policy rate to as high as 3.50% (percent), the decision to shift gears will largely depend on how the currency will react. If the news takes some pressure off the currency, then the BSP will likely stick to its plan of gradually hiking (or by increments of 25 bp) to 3.50% in the last four Monetary Board meetings,” said Dacanay.
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