WITH the economy’s gears moving far from full capacity and inflation expectations remaining anchored, Standard Chartered Bank expects monetary authorities to keep policy rate unchanged for the rest of the year, but noted that the central bank may be leaning towards a hawkish hold, rather than completely relaxing given upside risks to inflation.
‘In terms of the [Bangko Sentral ng Pilipinas] BSP itself, at the moment, my call, which I think is probably non-consensus, is I don’t expect the BSP to hike in August or for the rest of the year, for this year,’ Standard Chartered Bank Plc Senior Economist Jonathan Koh said during a virtual briefing last Friday.
While Koh expects the key interest rate to be kept unchanged at 4.75 percent, he recognizes ‘that it’s going to be a very close call.’
‘I think the BSP is still going to remain hawkish,’ added Koh, also the lender’s foreign exchange analyst for Asean.
Because growth is ‘really slow’ and demand inflation is soft, Koh said the central bank could look past supply-side driven inflation as long as inflation expectations remain anchored.
‘So from that perspective, because the output gap is negative, I do expect the BSP to remain on hold,’ added Koh.
Output gap
AS earlier explained by the central bank, output gap-measured as the difference between the actual and potential output-is a summary indicator of the relative demand and supply. That gap is being monitored by the BSP to assess the degree of demand-based inflation pressure.
The central bank explained that if the output gap is positive over time, prices will begin to rise in response to demand pressures. Similarly, if actual output falls below potential output over time, reflecting ‘economic slack,’ prices will begin to fall to reflect weak demand relative to supply.
In his explanation during a forum last Friday, BSP Governor Eli M. Remolona Jr. cited the 3.2 percent gross domestic product growth in the second quarter, which is way below the 2.3 percent outturn.
‘What’s also true is we’re below potential. Our potential [growth] may be 5 percent to 6 percent; close to 5.8 percent. Because we’ve been doing 5.8 percent in recent years, …we have what’s called an output gap: the difference between our potential and our actual growth. That matters for monetary policy.’
Remolona thus noted that with a negative output gap, this means that monetary authorities have ‘become less aggressive in terms of raising the policy rate in order to tame inflation.’
‘So we take account of both the weakness of our growth as well as our expectations of inflation,’ the BSP chief added.
According to Koh, the weak second-quarter GDP outturn points to increasing downside risks to domestic demand and raises the potential growth cost of further tightening.
Meanwhile, July inflation provided ‘nascent’ signs that price pressures may be moderating, with headline inflation easing to 6.2 percent year-on-year from 6.4 percent and core inflation moderating to 4.2 percent from 4.4 percent.
Toss-up
KOH opined, however, that one month of softer inflation ‘does not yet establish a sustained disinflationary trend, particularly as both measures remain above BSP’s target range.’ ‘We therefore expect a close decision between a hike and a pause,’ he added.
Koh said the August decision may depend on global oil prices and the performance of the Philippine peso in the upcoming weeks, ‘as renewed pressure on either could worsen the inflation outlook and increase the risk of second-round effects.’
At the June meeting of the Monetary Board (MB), he said the BSP governor noted that de-anchoring of inflation expectations was not a ‘significant’ concern at that time.
As such, Koh said the recent slight moderation in inflation may provide the BSP some room to assess the effects of its April and June rate increases.
‘However, persistent above-target inflation and upside risks to inflation from El Niño and minimum wage increases (suspended until 13 August) mean its communication is likely to remain hawkish,’ he added.
Unpredictable opponent
DURING the same forum last Friday, Remolona said the central bank is looking at inflation expectations and how other items in the consumer price index respond to the continuing global shocks.
He said these will affect the central bank’s policy strategy.
But with the growth and inflation numbers, Remolona said he thinks monetary officials ‘need a more convincing downward trend for inflation before we can relax.’
‘Of course the weaker growth that we’re seeing means we can be less aggressive in trying to tame inflation. But in the face of an unpredictable opponent, oil prices for example, we need to keep our eye on the ball,’ the central bank governor added.
The BSP has raised the key interest rate by a total of 50 basis points since the start of the conflict in the Middle East on February 28, delivering two separate quarter-point rate hikes at the MB’s rate-setting meetings held on April 23 and June 18.
These policy actions brought the target reverse repurchase rate to 4.75 percent.