Private banks foresee the central bank tightening its policy rates in the second half of the year, despite the slowdown in economic growth in the first quarter, as a precaution against mounting risks of inflation.
In a research note, the Bank of the Philippine Islands (BPI) said the Bangko Sentral ng Pilipinas (BSP) is likely to impose a 50-basis-point hike in policy rates in the third quarter to defend its inflation target of between 2 percent and 4 percent for 2015.
Inflation this year so far has gone past 4.1 percent, although that remains within the target range of 3 percent to 5 percent for 2014.
“As cost-push factors—[such as]the El Niño weather phenomenon—fuel inflation, the inflation-targeting central bank will move to snuff out any potential inflationary pressures,” it said.
BPI said it can see that the BSP will not hesitate to hike its policy rates by the second half of 2014 even if the growth prints continue to disappoint through the second quarter of the year.
The central bank is likely to raise rates especially if headline inflation starts approaching the 5 percent rate by the third quarter of 2014, it said.
Global bank HSBC views the slowdown in the Philippine economy as an indication the country is facing supply-side constraints, which could stoke inflationary pressures.
“Already, the negative supply shock from Typhoon Haiyan (Yolanda) pushed up food and household item prices. With electricity supply short and El Niño likely to cause lower-than-expected rainfall in the fourth quarter of 2014 and first quarter of 2015, upside risks to inflation are high,” HSBC economist Trinh Nguyen said in a research note for the bank.
Nguyen predicts supply-side constraints will push headline inflation higher in the third quarter.
A higher inflation rate will then force the central bank to raise interest rates to mop up excess liquidity and temper inflationary pressures, the economist said.
“This obviously will be costly for the central [bank]. Therefore, we expect the central [bank]to hold out as long as possible, employing one more RRR [reserve requirement ratio]hike before it resorts to policy and SDA [special deposit account]rate hikes. Ultimately, rates will have to be normalized,” she added.
Nguyen said another RRR hike may come as early as the June 19 meeting of the Monetary Board, while a policy rate increase by 50 basis points to 4 percent could happen by year-end.
At its May 8 meeting, the Board decided to keep the current interest rate for overnight borrowing or reverse repurchase facility at 3.5 percent and the rate for overnight lending or repurchase facility at 5.5 percent.
At the same time, the Board has decided to further raise the RRR for commercial banks by 1 percentage point to 20 percent effective from May 30 to guard against risks that could arise from strong domestic liquidity.