A former deputy governor of the Bangko Sentral ng Pilipinas (BSP) warned against the economy holding on to a negative real interest rate-when the nominal interest rate is lower than the country’s inflation rate-as the loss of purchasing power to inflation would be greater than the return earned on money.
In a commentary last Tuesday, former BSP Deputy Governor Diwa C. Guinigundo wrote that ‘a nominal policy rate of 5 percent may sound restrictive. But when inflation is above 6 percent, the real cost of money remains negative.’
Explaining further the concept behind a ‘negative real cost of money,’ Guinigundo told the BusinessMirror that the real cost of money is the nominal interest rate adjusted for inflation.
‘If the policy rate is 5 percent while inflation is above 6 percent, the real policy rate is still negative. In effect, the purchasing power lost to inflation is greater than the nominal return earned on money,’ he told this newspaper.
At a 5-percent policy rate and July headline inflation of 6.2 percent, Guinigundo explained in his commentary that the ex-post real policy rate remains about negative 1.2 percent.
Using the BSP’s own 2026 inflation forecast of 6.1 percent, the ex-ante policy rate is around negative 1.1 percent.
Even against its 2027 inflation forecast of 5.4 percent, it remains ‘slightly negative,’ added the former BSP deputy governor.
Anchored less firmly
WITH this, Guinigundo told the BusinessMirror, the main risk ‘is that monetary policy may not be restrictive enough to bring inflation back to target.’
‘Negative real rates can encourage borrowing and spending, discourage saving, and sustain demand even when the economy needs some cooling,’ he added.
Moreover, he said negative real rates can weaken the peso by making peso assets ‘relatively less attractive,’ especially if markets expect inflation to remain elevated.
‘If this persists, inflation expectations can become less firmly anchored, making inflation harder and more costly to bring down later,’ added Guinigundo.
Negative real rates impact
FOR households, he told the BusinessMirror that borrowers may still find credit ‘relatively inexpensive’ in real terms, while savers and fixed-income earners can see the real value of their money eroded by inflation.
This, he pointed out, can encourage consumption rather than saving.
For businesses, Guinigundo said negative real rates can support borrowing and investment, which he said is ‘positive’ if directed toward productive activities.
‘But if inflation and uncertainty remains high, businesses may still hesitate to invest despite relatively cheap money,’ Guinigundo emphasized.
‘The bigger issue is therefore not just the cost of credit, but confidence in future demand and economic conditions,’ he added.
For markets, Guinigundo said ‘persistently’ negative real rates can put pressure on the peso and encourage investors to seek better real returns elsewhere.
‘This is important because a weaker peso can, in turn, add to imported inflation, particularly through fuel and other dollar-priced commodities,’ he explained.
As such, he said the policy message is quite clear: ‘Monetary policy cannot a?ord to look only at the nominal rate. What matters is the real stance. With inflation still above 6%, a 5% policy rate remains accommodative in real terms.’
Direction correct
MOVING forward, Guinigundo pointed out that the challenge is to bring inflation down without unnecessarily sacrificing growth.
‘And that requires not only appropriate monetary policy but also credible fiscal and economic management and stronger supply-side measures,’ he added.
Guinigundo explained the concept behind real interest rate after he released a commentary that scrutinized the BSP’s forward guidance after the Monetary Board held its monetary policy meeting last August 27.
The BSP raised its policy rate by another 25 basis points last Thursday, bringing the target reverse repurchase rate to 5.0 percent.
‘It was the right direction,’ Guinigundo wrote.
However, he pointed out that the ‘more important question’ is whether it was enough and, more importantly, whether the BSP’s message was ‘strong enough to convince markets that it remains firmly committed to bringing inflation back to target.’
Reaction to hike
STILL, the former BSP deputy governor said the market’s immediate verdict was ‘hardly reassuring.’
Guinigundo noted that instead of strengthening after the MB’s decision, the peso weakened further, closing at a new record low of P61.888 to the dollar on Thursday and breaching P62 on Friday, at P62.265.
To be sure, he said the peso is influenced by global dollar strength, oil prices and other external forces.
But he pointed out that the peso’s immediate reaction to a rate hike is ‘nevertheless instructive,’ adding that the market did not seem ‘full convinced’ that the central bank had signaled an ‘unambiguous commitment to staying on top of inflation.’
With this, he said the issue is not simply whether the BSP should raise, hold or eventually cut its policy rate.
‘The more fundamental question is whether monetary policy is sufficiently restrictive in real terms to bring inflation back to target and keep expectations firmly anchored,’ added Guinigundo. He said the 25-basis-point increase therefore did not suddenly transform monetary policy from accommodative into restrictive. Instead, it merely made an accommodative real stance ‘somewhat less accommodative.’
Expectations shaped
FURTHER, Guinigundo said the BSP had earlier indicated that it could afford to be less aggressive because of the slowdown in economic activity, while ‘qualifying’ that position by the need to see a more convincing decline in inflation.
‘But markets may have interpreted the message as suggesting that the tightening cycle is already nearing its end,’ he pointed out.
Guinigundo then emphasized that central banking is partly about the current policy rate. ‘But it is also about shaping expectations of where policy is going,’ he added.
‘If households, businesses and markets begin to believe that the central bank is becoming more concerned about weak growth than inflation that remains substantially above target, expectations can become less firmly anchored. Once that happens, monetary policy may have to do considerably more later than it would have had to do today,’ he further explained.
A ‘preemptive move’
AT the monetary policy briefing on Thursday, BSP Governor Eli M. Remolona Jr. said they are ‘hoping that we won’t need another rate hike.’
However, Remolona also noted that the MB ‘will tighten as much as we need to, to bring the inflation rate down to its target.’
‘The [MB] is prepared to take monetary policy action as warranted to ensure that inflation returns to the 3-percent target, in keeping with its price stability mandate,’ the BSP said in a statement last Thursday.
The central bank said the measured increases in the policy rate will continue to anchor inflation expectations and mitigate the risk of further second-round effects.