Without an increase in interest rates, the speed of the depletion of the country’s dollar reserves could lead to a ‘significant’ peso depreciation, which could de-anchor inflation expectations.
In a commentary, Emilio S. Neri, Jr., Bank of the Philippine Islands’ (BPI) Senior Vice President and Lead Economist, said the bank expects the Bangko Sentral ng Pilipinas (BSP) to deliver a 25-basis-point policy rate hike on April 23, as the balance of risks has shifted toward a ‘more persistent and broad-based inflation environment.’
While current pressures remain largely supply-driven, Neri said historical experience suggests prolonged shocks tend to spill over into demand-side dynamics, increasing the risk of ‘de-anchored’ inflation expectations.
The BPI lead economist explained to the BusinessMirror that when inflation expectations become unanchored ‘it means that businesses, consumers, and investors no longer believe the central bank can or will return inflation to its target.’
‘This loss of credibility transforms inflation from a temporary headache into a self-fulfilling cycle,’ Neri also told this newspaper, adding that this leads to further inflation, which triggers even higher wage demands, creating a feedback loop that is ‘incredibly difficult to break.’
In his commentary, he said external vulnerabilities further complicate the outlook.
For one, Neri said the peso will likely remain under pressure as the situation in the Middle East remains ‘fluid.’
He noted that a sharper depreciation would ‘amplify’ imported inflation. ‘This foreign exchange-inflation feedback loop may ultimately become a binding constraint, and may require tighter policy even in the face of a supply-driven shock.’
He also noted that the country’s gross international reserves (GIR) declined significantly in March to a seven-month low of $107 billion, equivalent to 7.1 months of import coverWhile still adequate by what he called ‘traditional metrics,’ Neri said the downward trend in the GIR highlights ‘gradually eroding external buffers amid sustained global pressures.’
‘Without a rate hike, the speed of GIR depletion amid spot market intervention could lead to significant peso depreciation, which could ultimately de-anchor inflation expectations,’ he said.
Jonathan L. Ravelas, senior adviser at Reyes Tacandong and Co., said he also thinks a 25-basis-point hike is likely because inflation risks are ‘resurfacing’ and the BSP ‘doesn’t want to be caught reacting too late.’
According to Ravelas, there is a need for the central bank to implement a ‘calibrated preemptive response’ which he defined as ‘small, measured tightening now to anchor inflation expectations, support the peso, and preserve credibility, instead of risking much bigger hikes later.’
‘It’s the BSP tapping the brakes early so growth stays on track,’ Ravelas also underscored.
The Monetary Board, the BSP’s highest policy-making body, is set to hold its second scheduled monetary policy meeting for this year on April 23.
In an interview last week, BSP Governor Eli M. Remolona Jr. signaled that the central bank is on a wait-and-see mode while the Monetary Board is ‘waiting for spillover effects onto demand.’
Remolona said this as he pointed out that monetary policy tools are ‘demand-side’ tools which could not address inflation driven by supply shocks.
He, however, admitted that the second-round effects or the transmission of oil shock into local prices of goods may start to surface sooner than expected.
‘In the past it would be two to three months. But given how sharp the rise in oil prices has been, it may be quicker than that. So, this is kind of a new experience,’ added Remolona.