Fitch-owned BMI Research said the central bank is likely to tighten its monetary policy stance before the end of next year as inflationary pressures rise, while it attempts to stem capital outflows amid a more aggressive rate hike cycle in the United States.
Strong Philippine economic growth momentum will allow room for the Bangko Sentral ng Pilipinas (BSP) to prioritize macroeconomic stability over growth, BMI said.
“While we expect the BSP to maintain a neutral monetary stance through the first quarter of 2017, we believe that the central bank will be forced to hike its benchmark RRP [reverse repurchase]rate by 50 bps [basis points]to 3.50 percent before end-2017,” it said in a report released over the weekend.
After lowering the RRP rate to 3 percent from 4 percent on May 16 in the runup to adopting an interest rate corridor system on June 3, the central bank has kept the key policy rate unchanged for the rest of the year.
The Monetary Board also kept the corresponding rates for overnight lending and deposit facilities at 3.5 percent and 2.5 percent, respectively. The reserve requirement ratio was also kept steady at 20 percent.
Inflation hits bottom
Although inflationary pressures remained relatively muted, coming in at 2.5 percent year-on-year in November – which is at the lower end of the BSP’s inflation target corridor of 3 percent ± 1 percent – the inflation cycle has likely bottomed out, the research firm said.
“We expect price pressures in the country to continue to rise in the coming quarters with our average-inflation forecast standing at 3.3 percent in 2017 (versus 2.2 percent in 2016),” it said.
BMI sees this as an indication that real interest rates are likely to fall into negative territory, and BSP is, therefore, likely to be forced to hike interest rates before the end of 2017 in order to maintain macroeconomic stability.
Over the coming quarters, grain and energy commodity prices are also seen becoming positive drivers of inflation, as they are likely to post elevated year-on-year percentage increases due to the low base effects seen in first half of 2016.
Furthermore, BMI said the increase in electricity rates, along with the proposed upward adjustment in the excise tax rates of petroleum products, have the potential to be inflationary given that housing, water, electricity, and transportation account for about 30 percent of the Consumer Price Index basket.
It added that President Rodrigo Duterte’s approved P3.35 trillion budget for 2017—which will focus on infrastructure and social development, and will be positive for productivity growth—will, nevertheless, add to upside inflationary pressures.
US Fed move
While the US Federal Reserve’s decision to raise the benchmark funds rate by 25 basis points to a range of 0.50 percent to 0.75 percent on December 14, the Fed displayed a more hawkish path for monetary policy in 2017, increasing the median expectation to three 25 bps hikes from two in September, the BMI report said.
“This suggests that if the BSP maintains a neutral monetary policy stance through 2017, the Philippines’ narrowing real interest differential with the US will likely create additional selling pressures on the Philippine peso, and upward pressures on bond yields as capital outflows persist,” it pointed out.
The local currency has already sold off more than 8 percent since August 2016, while bond yields have risen by more than 140bps over the same period.
“Given recent weakness in the Philippine assets, we believe that the central bank will likely be forced to adopt a more hawkish stance in order to ensure financial market stability over the course of 2017,” it added.