With 17 months in a row of above-target inflation, some analysts are beginning to worry that the inflation-targeting Bangko Sentral ng Pilipinas (BSP) could miss its mark, misread the data, and find its credibility in question along the way.

For the record, as an inflation-targeting central bank, the BSP’s primary mandate is to maintain a “low and stable” consumer price index (CPI). To do this, the BSP with its arsenal of monetary tools must contain price pressures, manage liquidity and prevent the exchange rate from becoming inflationary if the peso depreciates too much versus the US dollar.

The Ayala-led Bank of the Philippine Islands (BPI) in a commentary said at this point, they see the possibility that the CPI or inflation will remain above the target in the next six months.

“It should be noted that inflation has been above the target of the BSP for almost 2 years already,” said BPI analysts.

The bank cautioned that a “longer period of above target inflation may affect the BSP’s credibility as an inflation targeting central bank, which in turn may limit their ability to control inflation.”

The inflation rate breached the government target range of two percent to four percent in April 2022 when it climbed to 4.9 percent from four percent in March of that year. The CPI increased in reaction to an impending global oil and other non-oil price upheaval when Russia invaded Ukraine on Feb. 28, 2022.

From April last year, the country’s inflation continued to rise until it peaked at 8.7 percent in January 2023. With BSP’s cumulative 425 basis points rate hikes that mirrored the US Federal Reserve rates, and its aggressive conduct of market operations, the CPI started to decline in February and continued to drop until July.

For the month of August however, it broke a six-month decline due to supply shocks. Because of bad weather, inflation rose in August due mainly to the faster price increases of rice, vegetables, and fish. Non-food inflation also went up because of transport inflation on account of higher fuel prices.

The average inflation remains above-target at 6.6 percent for the first eight months of 2023.

The BSP however maintains that despite the uptick in the August inflation, which was expected, it still expects CPI will fall within the two percent to four percent target range in the fourth quarter of this year “in the absence of further supply shocks.”

BSP officials led by BSP Governor Eli M. Remolona are confident in their assumption that inflation will even be below the low end of the target, or below two percent in the first quarter of 2024. The inflation target which the BSP announces two years in advance, is defined in terms of the average year-on-year change in the CPI.

Based on the latest Monetary Policy Report of the BSP (August 2023), inflation is projected to average at 3.4 percent in the fourth quarter this year, within the target band.

The BSP also said that by the first quarter of 2024, the inflation rate will be around 2.4 percent but will “accelerate near the upper end of the target range” in the first two quarters next year.

The expectation is that by the second quarter of 2024, CPI will average at 3.6 percent and 3.7 percent by the third quarter.

The factors behind the forecast levels are positive base effects, higher crude oil prices, and the lagged impact of minimum wage adjustments, before settling slightly above the midpoint of the target in 2025, said the BSP. It added that the negative base effects until January 2024 will be favorable for the inflation path as well.

On the domestic front, the BSP said the waning impact of transport fare hikes in the last six months of 2022 were the negative base effects for the same period this year, hence the decelerating inflation.

There are upside risks to inflation such as more transport fare hikes and minimum wage adjustments, as well as higher prices of key food items and the impact of El Niño weather conditions on food and electricity prices which could lead to renewed second-round effects.

As of its Aug. 17 Monetary Board policy meeting, the BSP forecasts CPI of 5.5 percent for this year which is still way beyond the target, while the projection for 2024 is 3.3 percent and 3.4 percent for 2025 -- both are within the target band.

BSP Deputy Governor Francisco G. Dakila Jr. has said that BSP continues to refine its inflation forecasting models. The BSP has been developing a new template for its future forecasting workhorse model.

The BSP is also improving its existing quarterly projection model or the Policy Analysis Model for the Philippines (PAMPh).

In an email to Manila Bulletin previously, the BSP said that an enhanced model will allow it to “present a more detailed outlook of inflation and growth, along with their components, as well as a richer discussion of how the BSP’s various policy tools can affect the broader economy.”

This new model will be “extensively tested” before the BSP uses it publicly. “In due time, we will also familiarize the public with how the model will be used at the BSP's monetary policy meetings,” said the BSP.

Currently, the BSP forecasts inflation using the Multi-Equation Model or MEM. The BSP describes MEM as its workhorse model for macroeconomic forecasting and policy simulations.

Meanwhile, an improved PAMPh will complement MEM. The MEM is an econometric model with a system of equations aimed at providing a comprehensive view of the macroeconomic outlook over the policy horizon by capturing the main aspects of monetary transmission in the country.

The PAMPh which is based on the Forecasting and Policy Analysis System developed by the International Monetary Fund, has already re-defined the structure of interest rates based on the policy rate and market rate to ensure a more representative transmission of monetary policy to the economy. It has also re-defined the real exchange rate relative to the US dollar as the trade-weighted real effective exchange rate, and re-calibration of parameters.

However, the current PAMPh, limited in its “predictive power” for near and medium-term horizons, do not as yet include some sectors of the economy such as the fiscal and external sectors.