Policy easing not on BSP’s radar yet

Bangko Sentral ng Pilipinas (BSP) Governor Eli M. Remolona, Jr. maintained his “hawkish stance,” saying that monetary policy easing is not on the “radar” given still-above target inflation.

Mr. Remolona on Tuesday said sudden reversals in monetary policy confuse the market and create uncertainties.

“We’re in a hawkish stance, which means either we pause or we raise. We’re still not comfortably within the target range… A cut is not on our radar screen,” he said during a gathering with newspaper editors at the BSP.

Last week, the BSP extended its policy pause for a third straight meeting, keeping the benchmark interest rate at a near 16-year high of 6.25% amid upside risks to inflation.

The BSP has raised borrowing costs by 425 basis points (bps) from May 2022 to March 2023 to tame inflation.

Headline inflation slowed for a sixth straight month to 4.7% in July, which also marked the 16^th straight month of inflation exceeding the BSP’s 2-4% target band.

Inflation averaged 6.8% in the first seven months of the year, which is still above the central bank’s revised 5.6% forecast.

Former BSP Deputy Governor Diwa C. Guinigundo said the BSP’s hawkish monetary policy stance is “most appropriate” as both headline and core inflation remain elevated. 

“With these inflation dynamics it would be counterintuitive for BSP to even consider cutting the policy rate or reducing the required reserves. That would indeed confuse the market, or upset inflation expectations,” he said.

Core inflation, which excludes volatile food and fuel prices, slowed to 6.7% in July from 7.4% in June. For the first seven months of the year, core inflation averaged 7.6%.

Mr. Guinigundo said that a pause is consistent with cautious monetary policy.

“The next meeting of the Monetary Board (on Sept. 21) is critical because that would validate whether the upside risks (to inflation) would materialize. Then the econometricians in the research department would be able to incorporate the outcome in their next run and see how the forecasts would work out,” he said.

At its Aug. 17 meeting, the Monetary Board identified potential price pressures linked to the “impact of possible higher transport charges, higher minimum wage adjustments, persistent supply constraints on key food items, and the effects of El Niño weather conditions on food prices and power rates.”

In deciding to extend the pause, the BSP also recognized the “challenging outlook” for the economy, as the slower-than-expected 4.3% second-quarter gross domestic product (GDP) expansion reflected a broad-based slowdown in domestic demand.

“A slowdown in growth is something that we should expect from this fight against inflation. Monetary policy is the right tool for stabilizing inflation,” Mr. Guinigundo said.

He noted that fiscal policy and non-monetary measures by the Trade and Agriculture departments should “provide the counterweight to weakening growth momentum.”

“We don’t use monetary policy to address government underspending or weak investments, the major reasons behind the 4.3% (growth) in the second quarter,” he added.

HSBC economist for Association of Southeast Asian Nations (ASEAN) Aris Dacanay in a note on Wednesday said the BSP is unlikely to cut policy rates even with slowing economic and easing inflation, mainly because of the US Federal Reserve

“Across ASEAN, the Philippine economy has the least monetary policy freedom from the Fed. The current account deficit is still wider than pre-pandemic levels and cutting ahead of the Fed risks putting downward pressure on the peso,” he said.

Based on the latest central bank data, the current account deficit was at $4.3 billion or equivalent to -4.3% of GDP in the first quarter, up from $4 billion a year ago.

The current account deficit is projected to reach $15.1 billion or -3.4% of GDP this year.

The peso closed at P56.73 on Wednesday, falling by 35 centavos from P56.38 previously. Year to date, the peso depreciated by 1.7% or 97.50 centavos from its P55.755 close on Dec. 29.

RRR cut in Q4?
Meanwhile, Mr. Remolona reiterated the BSP is taking a cautious approach in cutting banks’ reserve requirement ratios (RRR).

“If we’re tightening, we should not cut RRR. But my target is to lower it eventually,” he said.

HSBC’s Mr. Dacanay said he expects the BSP to cut the RRR of big banks by 100 bps to 8.5% in the fourth quarter this year, when inflation reaches the 2-4% target and economic growth continues to slow. He noted the Philippines still has the highest RRR level in the Southeast Asian region.

“We estimate the cut to inject PHP 127 billion of liquidity in the system, of which the BSP will likely neutralize using its constantly improving array of monetary tools; this is to ensure that the central bank’s monetary stance does not change even with a cut in the RRR,” he said. 

Earlier in June, the BSP cut the RRR for big banks and nonbank financial institutions with quasi-banking functions by 250 bps to 9.5%. It has also reduced the ratio for digital banks by 200 bps to 6% and by 100 bps for thrift banks, and rural and cooperative banks to 2% and 1%, respectively.

Although the cut in RRR does not imply a change in monetary stance, the liquidity injected can be absorbed easily by the BSP’s monetary toolkit, Mr. Dacanay said.

“The central bank, nonetheless, wants the RRR cut to be consistent with monetary policy to limit confusion in the market. This means inflation needs to be well within the central bank’s target range before a cut is announced,” he said.

However, Mr. Dacanay said that if the peso weakens further against the dollar in the fourth quarter, the BSP may not cut the RRR.

“HSBC Foreign Exchange (FX) Research team’s base case is for the peso to strengthen to P54.50 against the dollar by the end of 2023. This should provide the BSP room to cut the RRR without the peso breaching P57. Without this buffer, however, the BSP may opt to delay the RRR cut to a later date,” he said.

HSBC Global FX Strategist Lenny Jin in the same note said Philippine markets tend to reward good RRR cuts and penalize the bad cuts.

“When RRR cuts help to ease growth constraints while inflation and currency pressure is relatively contained, the peso will likely react positively,” she said.

“The risk is that, should the dollar downtrend not be established by yearend or if inflation remains too close to the upper-band target, a RRR cut may see similar negative reactions in 2018.” — Keisha B. Ta-asan