A day after lifting the key rate to six percent, Bangko Sentral ng Pilipinas (BSP) Governor Felipe M. Medalla on Friday, Feb. 17 may have hinted of a possible 50 basis points (bps) policy rate hike next month to prevent the disanchoring of inflation expectations.
“There’s a big risk (of) inflation expectations being disanchored,” Medalla told Bloomberg TV.
While he reiterated that they will likely increase the borrowing rate by 25 bps to 50 bps on March 23, he also said that when deciding on monetary policy actions, it is easier to correct a large increase than to hike rates too little, too late.
Medalla said that adjusting the BSP key rate by 25 bps was considered “dovish” and they opted for a 50 bps last Feb. 16. In monetary policy speak, dovish means a preference for low or steady rates in aid of growth, while a hawkish stance is to tighten policy settings to curb inflation.
“From our point of view there are two mistakes that we can make, one is raise too much and the other (is) to raise too little,” Medalla said. “If we raise too much, it’s so easy to correct in future policy meetings. If we raise too little, inflationary expectations could be disanchored and that will be very hard to reverse,” he said.
Meanwhile, Medalla commented in his CNBC interview on Friday that initially, they have considered only a 25 bps rate hike for its Feb. 16 decision based on its forecast that January 2023 inflation will settle at 7.9 percent to eight percent. The result however was surprisingly high at 8.7 percent inflation versus 8.1 percent in December 2022 and against consensus forecast of 7.6 percent to 7.7 percent.
“We decided it will be more prudent to do a big 50 bps,” he said.
Medalla told both Bloomberg TV and CNBC that the high inflation is its primary concern and controlling second-round pressures coming from the demand side, such as prices of rentals and restaurants, as well as looming wage and transport fare increases, is their main challenge right now.
“We’re seeing we may have second-order effects. The prices of services are also beginning to rise despite (that) shortages are limited to food. I think 25 bps would have been considered too dovish,” he said. “There’s also some demand-side issues such as rentals and restaurant prices. We’re beginning to see inflation for services rise also,” he added.
On the day the BSP lifted the key rate to six percent, Medalla said the Monetary Board believes that the economy is strong enough to deal with high interest rates, given the 2022 gross domestic product (GDP) growth of 7.6 percent, and that “monetary action can help to dampen potential demand-side pressures and second-round effects without unduly hindering the sustained momentum of economic growth.”
He told reporters on Thursday that the economy as measured by GDP growth, will only be affected by a reduction of 0.04 percent for every 50 bps rate hike.
“(As to the) impact on growth (of inflation) fortunately, the economy is quite strong. (But) a rate hike of 50 bps will cut growth by just 0.04 percent of GDP. That’s our model. Usually models we have margins of error, it could be 0.02 percent to 0.06 percent,” said Medalla.
Another 50 bps rate increase will take the reverse repurchase (RRP) or overnight borrowing rate to 6.5 percent by March 23.
This will be the first time the RRP will touch a 6.5 percent rate. The closest was 6.75 percent on July 3, 2003 when the BSP cut the RRP by 25 bps from seven percent. It stayed at 6.75 percent until April 7, 2005 which was when the BSP raised it back to seven percent to deal with high inflation at the time as well.
“If you think zero, 25, 50, 75, I think the extremes could be ruled out,” said Medalla. This was the same comment he made during the Feb. 16 press briefing, where he ruled out a rate adjustment higher than 50 bps in the next two or three policy meetings.
“Depending on the data, most likely, it is a choice really between 25 or 50 in the next meeting unless we see an actual negative month-on-month inflation. Now the only way that will happen is there is significant increase in supply of the products that are now very short,” said Medalla.
The BSP chief said inflation is usually about rice and fuel prices. “It’s now due to the addition of many things. For instance meat, eggs and vegetables. And of course because of strong demand in rentals and restaurant prices,” he explained.
After March 23, the next Monetary Board policy meetings will be on May 18 and June 22.
The BSP revised higher its inflation forecast for 2023 to 6.1 percent from its Dec. 15, 2022 estimate of 4.5 percent, while for 2024, the forecast is also higher at 3.1 percent from its previous 2.8 percent.
The BSP expects inflation to average to about 7.7 percent in the first half of 2023, before dropping to 5.4 percent in the third quarter. It is hoping that with the policy rate adjustments and non-monetary measures such as importation to address supply issues, inflation could settle below four percent at 3.8 percent in the fourth quarter this year.
By early 2024, inflation is expected to be closer to the lower end of the two percent to four percent government target because of the dissipation of supply-side pressures from oil and non-oil commodities.