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BusinessWorld 4 MIN READ

Higher inflation expectations fuel household spending

January 24, 2025By BusinessWorld
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Expectations of rising prices prompt households to increase spending, which may cause inflation to be more persistent, according to a discussion paper by researchers at the Bangko Sentral ng Pilipinas (BSP).

“Our empirical results indicated that households tend to increase their planned consumption in the near term when they expect higher prices. This is particularly true for essential commodities like food and non-alcoholic beverages, fuel, and utilities,” the researchers said.

The discussion paper, authored by BSP Research Academy Principal Researcher Faith Christian Q. Cacnio and Research Associate Cymon Kayle Lubangco, explores the effect of inflation expectations on household consumption.

“Moreover, the proportion of households that intend to increase their consumption in the near term grows within higher inflation expectations,” they added.

In its latest Consumer Expectations Survey, the BSP said households still expect inflation to increase in the near term. Household inflation expectations may remain above the 2-4% target range in the near term.

“We also observed that a larger number of households tend to expect elevated prices for commodities with greater consumer price index (CPI) weights when actual inflation is within target than during low and high inflation periods,” the BSP researchers said.

“This results in higher average expected inflation during quarters when inflation is within target.”

Headline inflation averaged 3.2% in 2024. The BSP also expects inflation to remain within the 2-4% target band from this year to the next, as its baseline projections are at 3.3% and 3.5% for 2025 and 2026, respectively.

However, the central bank has warned that the balance of risks to the inflation outlook until 2026 remains on the upside.

“The planned expenditure for a specific commodity is more responsive to expected price changes for that commodity than to the overall household inflation expectations,” according to the researchers.

They found that inflation expectations tend to be sensitive to price movements of key commodities such as oil and rice, as well as currency appreciation.

“In assessing the potential effect of certain shocks, we observed that households’ inflation expectations rise with increases in international benchmark prices of oil and rice and decline in response to higher policy rates and an appreciation of the Philippine peso,” they said.

“Conversely, higher international prices of oil and rice lead households to increase their near-term consumption in anticipation of higher future inflation,” they added.

Fuel and rice are usually among the main sources of local inflation. In particular, rice is typically the biggest contributor to overall inflation.

However, rice inflation has been on a downtrend in recent months after the government slashed tariffs on rice imports in July.

“Following an oil price shock, the likelihood of purchasing durable goods within the next 12 months also increases significantly,” the researchers said.

“Furthermore, a depreciation of the Philippine peso results in a notable rise in the average likelihood of increased consumption of various goods in the next period.”

The peso has been under pressure in recent months as the dollar surged after US President Donald J. Trump’s victory and expectations of slower rate cuts by the US Federal Reserve.

Last year, the peso sank to the record-low PHP 59-per-dollar level three times.

“Linking changes in household inflation expectations to consumption behavior, our simulation results suggest that an increase in the policy rate will lead households to defer increasing their consumption of most commodities.”

The study’s simulation results showed that an increase in the policy rate helps “moderate inflation expectations, which, in turn, affects consumption spending.”

However, it noted that shocks to international oil prices and currency fluctuations have a “more pronounced impact” on inflation expectations and spending versus policy rate changes.

“This highlights the significant effects of supply-side shocks on inflation expectations and economic activity.”

“Supply-side shocks are generally considered to have temporary and short-lived effects on prices and do not necessarily warrant a monetary policy response,” they added.

The BSP researchers said central banks must “remain vigilant to prevent these shocks from leading to second-round effects.”

“Central banks should continue to closely monitor price developments in goods and services, even when inflation is within target, as households tend to form higher inflation expectations during this period.”

“Clear communication is crucial to curb these expectations and keep them aligned with the inflation target. Understanding the potential effects of supply-side shocks on inflation expectations and, subsequently, on household consumption could also help calibrate central banks’ necessary responses.”

The BSP began its easing cycle in August last year, cutting rates by a total of 75 basis points to bring the benchmark to 5.75%.

BSP Governor Eli M. Remolona, Jr. has said there is still room to reduce interest rates further as the current policy rate is still restrictive.

The Monetary Board’s next rate-setting meeting is on Feb. 13. — Luisa Maria Jacinta C. Jocson

This article originally appeared on bworldonline.com

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