Renewed inflation risks will likely prompt the Bangko Sentral ng Pilipinas (BSP) to embark on quarterly interest rate hikes next year, Japan’s Nomura said.
In its Asia Economic Outlook report, Nomura raised its 2018 inflation forecast to 4.3 percent from 3.9 percent, higher than the BSP’s 2 percent to 4 percent target.
“This forecast is partly driven by our new 2018 oil price assumption ($65 per barrel), combined with the impact of tax reform (assuming the House version is adopted) and the output gap becoming more positive despite potential growth rising to an estimated 6.2 percent,” it explained.
Nomura said the Bangko Sentral would not be able to ignore the risk of headline inflation breaching the target.
As a result, it expects monetary authorities to hike policy rates by a total 100 basis points (bps) to 4 percent at a rate of one 25 bps hike per quarter.
Nomura recalled that in 2014—the last time BSP hiked rates—it was all about inflation risks, with the rate hikes characterized by the central bank as a “preemptive response” to the balance of risks around inflation experiencing “a further upward shift”.
“We think demand-side pressures are even stronger today than in 2014 and thus inflation expectations are also likely to accelerate amid supply-side increases from oil prices and tax reforms,” it said.
The BSP — after lowering its reverse repurchase rate to 3 percent from 4 percent on May 16 last year in the runup to adopting an interest rate corridor system on June 3, 2016 — kept the policy rate unchanged at its November 9, 2017 meeting.
Nomura also said that the risk of markets viewing Bangko Sentral as behind the curve—particularly when other regional central banks are signaling normalization—may add to overheating concerns.
“The IMF’s latest Article IV report suggests that the ‘credit-to-GDP (gross domestic product) gap’ is now approaching early warning levels,” it said.
Nomura said that monetary authorities could implement macroprudential measures, for example by targeting a reduction in bank exposures to mortgages.
However, these will have to be carefully balanced against the BSP’s long-running objective to reduce the reserve requirement ratio (RRR) from the currently high level of 20 percent.
The RRR is the portion of depositors’ balances that banks maintain with the Bangko Sentral in the form of cash and other liquid assets.
Nomura said it continued to believe that any RRR changes would remain dependent upon the implementation of capital market reforms, which will take time.
“Policy rates remain the main tool that BSP will deploy in response to higher inflation,” it concluded.