OF SUBSTANCE AND SPIRIT
Today is the last meeting of the Monetary Board of the BSP for the year 2023. Early this week, we wrote in GlobalSource Partners In Brief that the BSP must be at a crossroads on what to do next, whether to pause, or lift its policy rate by another 25 basis points.
We are convinced easing is not on the agenda today.
Based on the Philippine Statistics Authority (PSA) report on the November 2023 headline inflation rate, last month’s inflation rate of 4.1 percent is the third consecutive monthly slowdown of year-on-year inflation. It’s nearly half of last year’s November inflation rate of 8.0 percent. But while price movements are on a downtrend, actual inflation for the first 11 months of 2023 averaged 6.2 percent, way above the 2-4 percent inflation target. In the last six years, we are seeing that this year’s inflation would be the highest at more than 6.0 percent.
The so-called risk-adjusted inflation forecasts for both 2023 and 2024 as of last month remained outside the inflation goal. It is quite obvious that the risks to inflation continue to be heavily on the upside.
We reiterate that the BSP must be deciding whether to go for another 25 basis points as the targets remain elusive, or keep the policy rate steady as previous monetary tightening is yet to be fully felt. To be clear about it, both options are hawkish, and both may be considered appropriate.
At the current 6.5 percent, our local policy rate exceeds the US Federal Funds rate of 5.25-5.5 percent. But the differential must be higher when we adjust for their respective country risk premia, that measure that tells us how the market perceives the risk of buying and holding Philippine assets. The last time we consulted Bloomberg, it looks like the Philippines’ risk premium continues to moderate with the easing of both headline and core inflation while economic growth is holding. That is positive to the crusade against inflation.
Yes, not all macroeconomic indicators point to the right direction, but those that do not may not be bad enough to weaken the improving market outlook and risk perception on the Philippines.
We view this easing market sentiment continuing through December 2023 given some negative base effects. Data shows that December 2022 headline inflation peaked at 8.1 percent.
What caused the retreat of various commodity inflation last month?
As reported, food supply and logistics improved a great deal, with the heavily-weighted food and non-alcoholic beverages recording a lower inflation of 5.7 percent from 7.0 percent in October. It was vegetables, tubers, plantains, cooking bananas, complemented by the favorable price movements in fish and other seafood products that drove food inflation to further decelerate.
Lower price growth of transport as well as of restaurants and accommodation services further supported the diminishing momentum of price movements in November 2023. The rest of the consumer basket of goods and services exhibited either actual decline or zero price movement.
Those are the good news.
But this is the catch: the same drivers could reverse in the near future and arrest the downtrend in inflation. Food prices could resurge if Executive Order 10 that reduces tariff rates on such food commodities as rice, corn and pork is not extended beyond Dec. 31, 2023. Moreover, other supply shocks are imminent for the other food commodities. No question about it, El Niño dry spell could spill over through the end of the first half of 2024. Higher transport cost is a real, very probable risk because of pending adjustments in the jeepney, taxi and MRT fares. Immediate consolidation of jeepney operation could be costly and inflationary. Prices could rise again once wages are adjusted outside Metropolitan Manila. Oil prices are far from secured due to the raging hostilities in Israel. Power rates become vulnerable.
True, demand pressures are receding based on the downtrend in core inflation but the levels are sticky downward. Eleven-month average remains way above the 2-4 percent inflation target.
As a flexible inflation targeting central bank, the BSP is guided first by its own forecast of inflation during the policy horizon through 2025. With long and variable lag of monetary policy, we believe BSP will not immediately turn dovish. Its current risk-adjusted inflation forecasts of 6.1 percent for 2023, 4.4 percent for 2024 and 3.4 percent for 2025 remain outside acceptable levels relative to the official target. We don’t doubt, the lower November inflation print will reduce the risk-adjusted forecasts to be presented to the Monetary Board today. We also expect inflation expectations to be lower because of the BSP’s sustained hawkish communication.
All up, a more circumspect monetary authority will choose to play it safe and keep the policy rate at 6.5 percent for the time being and at least maintain a steady differential vis-à-vis the US Fed’s target interest rate. A weakening of the peso is a potential outcome, and that could motivate another price surge.
We would prefer, however, a more hawkish approach of jacking up the policy rate anew because we doubt whether the remaining potency of previous adjustments would be adequate safeguard against the effects of those upside risks on inflation for the next two years. Outside the debates on food sufficiency, we have yet to see a more significant impact of non-monetary measures. It is difficult to hold on to those strong, hawkish statements to keep inflation expectations moored unless the market actually sees the intended effects.
The argument that high interest rates could affect the trajectory of credit and economic growth holds little water because one, credit continues to expand, and two, the third quarter GDP growth shows a resilient economy. On the surface, credit and liquidity growth appears limited because of the BSP’s tight monetary policy. It should not be lost on us, however, that it was the banks themselves which have opted to tighten their own lending standards especially for corporates.
The BSP can by all means remain patient with “higher interest rates for longer.”