Philippines: BSP to cut rates soon
- Philippines growth fell short to 5.6% from 6.3% in 4Q18, the lowest since 1Q15
- Inflation has eased significantly and is likely to remain benign
- PHP is likely to continue to outperform EM Asia as interest rates might still be competitive
- Implication to forecast: BSP is likely to cut policy rate by 50bps this year
- Implication to investors: We remain constructive on peso and local currency government bonds
Philippines growth fell short to 5.6% from 6.3% in 4Q18, the lowest since 1Q15. The low growth was mainly due to 2019 budget approval delay which also include P95.3bn cut in infrastructure spending as well as weak exports. The budget was approved on April 15th, two months after operating under re-enacted budget in which new project could not be started. Budget delay and infrastructure spending cut could impact negatively on growth as the economy has relied on public investment as the main driver of growth. In addition, this year’s El Niño and power outage has also affected growth especially on agriculture and manufacturing sectors.
Although budget delay was mainly to blame for the lacklustre growth, the impact of weakening trade balance to growth could not be ignored. Mar19 trade balance had widened further to -USD3.1bn with exports growth remain in negative territory. Overall balance has improved from 4Q18, but further deterioration is likely given climbing oil price and trade tension between US and China. Yet, despite higher external headwinds from trade sides, Peso has been supported by capital inflows..
On the other side, inflation has eased significantly so far this year and is likely to continue. Inflation eased to 3% in April, the slowest in 16 months despite El Niño and higher oil price. Domestic demand might be more subdued than most expected as the impact of delayed budget and lower exports has outweighed the impact of lower inflation rate. We think inflation would ease further this year as domestic demand remain soft and food price are stable. These two factors combined might outweigh the impact of higher oil price.
Easing of consumer price, which has returned to BSP’s target of 2-4% this year, combine with slower growth momentum has provided room for the central bank to unwind last year’s monetary tightening with a combination of both RRR cut and policy rate cut. We think a cumulative of 50bps this year is likely and could start as early as today’s policy meeting with 25bps cut, especially if growth, which will be announced later today, disappoints.
PHP doesn’t have to weaken on rate cuts
Since the start of 2019, we have been constructive on both Philippine local government bonds (RPGB) and the peso (PHP). One comment we have been getting from our last report “Philippine Bonds: Soaring returns” (see here) is the following: BSP has turned dovish and is expected to cut rates much more than peer central banks, therefore PHP should depreciate. Our response to that argument is that PHP doesn’t have to and in fact, we expect PHP to continue to outperform EM Asia currencies. Our basis is that interest rate support could stay strong because the BSP would be cutting rates from a rather high level. If BSP cuts 50bps by end-2019 (DBS forecast), the ending policy rate of 4.25% is still likely to be higher than many peers. Fundamentally, PHP's drivers are also more idiosyncratic/domestic-driven. If inflation continues to moderate and stabilize within BSP’s 2-4% target range, we don’t see a strong case for significant PHP depreciation.
Looking at price trajectory. Since end-March, the PHP has rallied against most EM Asia currencies despite more dovish comments by BSP Governor Diokno (he recently described policy rate and RRR cuts as “inevitable” and “just a matter of timing”). Markets seem to be reacting quite positively to the impending easing as BSP is not expected to fully unwind 2018 rate hikes. Additionally, easing could help to offset the drag that has come from the budget. At last week’s Asian Development Bank meeting, Governor Diokno maintained that the PHP “still reflects true value” and “there is no need to build up FX reserves.”
For Philippine rates, there are no market instruments from which we can precisely infer the amount and timing of rate cuts that is priced in. However, judging by the shape of some of the curves (e.g. RPGB, PHPUSD NDS), we suspect markets have not priced in much of the expected easing (yet). Therefore, there is scope for RPGB curve to bull-steepen ahead. S&P's recent upgrade of Philippine's credit rating to BBB+ from BBB should also be supportive of bond prices. Ultimately, we think RPGB’s strong year-to-date performance still has legs.
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