Philippines: More tightening to come after surprise hike

The BSP surprised with an off-cycle 75bps policy rate hike, bringing the key rate to 3.25%, with more tightening likely.
Group Research, Chua Han Teng15 Jul 2022
  • Sustained and broadening prices pressures continued to underpin the tightening stance
  • Spillovers that could potentially unhinge inflation expectations were also considered
  • The PHP’s weakness vs the USD, driven by diverging monetary policy, would fan imported inflation
  • The surprise and forceful policy rate hike has lowered the bar for aggressive policy tightening
  • Forecast implications: A 50bps hike during August’s meeting is in play
Photo credit: Unsplash Photo

The Bangko Sentral ng Pilipinas (BSP) surprised on multiple fronts with yesterday’s unexpected announcement. First, the Philippine central bank delivered an increase to its key policy rate (overnight reverse repurchase rate) that was outside of its usual scheduled meeting. The BSP was scheduled to review its monetary policy stance in August, following the 25bps hikes in each meeting in June and May. Second, it opted for a large quantum of 75bps increase to 3.25%. It was bigger than the potential 50bps that might have taken place during the August meeting, which was signalled and considered earlier by Governor Medalla. It was also larger than the 50bps seen in a single meeting during the interest rate hiking cycle in 2018.

Key takeaways from Monetary Board’s release

The BSP’s hawkish stance was clearly reflected in the Monetary Board’s press release that justified the surprise tightening. Sustained and broadening price pressures continued to be the key factor underpinning the central bank’s tightening and normalisation stance. Headline inflation remained well above the BSP 2-4% target range at 6.1% YoY in June, marking the fastest increase since late 2018. Beyond rapid commodity price increases, the BSP is also observing signs of second-round price effects that were mentioned previously. Therefore, the BSP saw an urgent need to anchor inflation expectations and temper upside inflation risks.

What was notable in the press release was the mention of policy helping to ‘manage spillovers from other countries that could potentially unanchor inflation expectations.’ We think this might be referring to the Philippine peso’s weakness against the US dollar that would fan further imported inflation, which the BSP wishes to contain.

The PHP is among the worst performing currencies in the region (alongside the South Korea won). The PHP has depreciated by ~9% vs the USD year-to-date, and is also weakening at its fastest YoY pace in many years. The peso’s weakness has been partly driven by diverging monetary policy stance with the US, amid a wide goods trade deficit. Philippines’ positive policy interest rate differential with the US has diminished further following the jumbo 75bps US Fed Fund rate hike in June. The differential would have narrowed even more, if the BSP had not adopted the off-cycle tightening. US tightening expectations for the July meeting have turned more aggressive, following the hot US June inflation print of 9.1% YoY – a 41-year high. On growth, the central bank continues to take comfort from the recovery, which we think is supported by opening dynamics as pandemic woes reverse.

More BSP hikes ahead to dampen inflation

The surprise and forceful policy rate hike on July 14 has lowered the bar for aggressive policy tightening. The BSP remains firmly committed to its price stability mandate over the medium-term, and is likely to stay hawkish to dampen elevated inflation pressures. August’s meeting is set to take place as scheduled, according to Governor Medalla. A 50bps hike in August is in play. There is still room to normalise and tighten policy at a fast pace to return to the pre-pandemic level of 4.0%. The likelihood of the policy rate reaching 4.5% by end-2022 is decent, especially if high inflation remains sticky above the BSP’s 2-4% target range.

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Chua Han Teng, CFA

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