WHEN it was announced earlier in the week that inflation in July had ebbed to a 20-year low of just 0.8 percent, very few analysts were surprised; having the benefit of an unambiguous, year-long trend on which to base their predictions (see chart), all of the analysts polled by The Manila Times accurately predicted a low range (from about 0.6 percent to about 1.3 percent) for inflation in July, and a few even correctly guessed the eventual 0.8 percent result.
This kind of predictability is good, because it indicates that at least some parts of the economy are not particularly susceptible to volatility caused by external influences. The economy is affected by things like the slowdown in China, depressed oil prices, and uncertainty in the eurozone, but the impact is largely being absorbed and then manifested in a gradual way.
Inflation, which is a particularly sensitive indicator, has declined fairly steadily over the past 13 months, but what we have not seen are big changes of a couple of percentage points from one month to the next, or changes in direction. The most extreme month-to-month difference was in December last year, when the inflation rate shed one percent from November’s rate, and only once, in February this year, has inflation accelerated from the preceding month—and by only 0.1 percent, at that.
That’s the good news about inflation, because it suggests that if the country’s monetary authorities are on their toes, they will be able to manage the problem super-low inflation otherwise is without resorting to extreme measures.
The bad news is they may not be on their toes. Although the BSP is adamant that the country is not headed for deflation (something that is several orders of magnitude more difficult to correct than inflation), there is apparently nothing stopping it from passing into negative territory between now and October. While the BSP and other analysts offer the presumption that increases in both government and household spending toward the end of the year will pull the inflation rate upward as a basis for their optimism, other more concrete indicators that should be putting upward pressure on inflation are not having that effect.
Oil prices do have a positive impact on inflation, but because inflation is fundamentally a function of demand and money supply, they do not have as big an effect as factors like gross international reserves, exchange rates, and the actual volume of money floating around the financial system. GIR has increased from last year, although at a very slow, variable pace, and now stands at $80.4 billion, up from a monthly average of $79.92 billion through 2014 ($80 billion is unofficially considered an upper limit by the BSP). A strong US dollar has driven down the value of the peso; it closed at P45.79 on Thursday, a new five-year low. And while growth in money supply (M3) has decelerated, it is still increasing at about 9 percent a month, and now stands at about P7.7 trillion.
All these things should be putting upward pressure on the inflation rate, and would counteract the downward pressure from oil prices if demand kept up with the availability of money. Ordinarily, it should —having more money available lowers the relative cost of things and encourages spending (i.e., a Cantillon Effect)—but here in the Philippines demand is evidently declining.
What the ramifications of all this will be in the time between now and the end of the year are difficult to predict; the current situation is unusual because it is the opposite of what should be happening. With inflation declining at a steady rate in spite of the current policy, it seems clear the one thing current policy has not addressed—consumer demand —is where the problem lies.
The only way to address that problem—as I wrote back in June, when the first red flags about inflation appeared —is for the BSP to lower its interest rates. It will, eventually; all central banks do, once they’re faced with deflation. It would be preferable if it didn’t come to that.