OF SUBSTANCE AND SPIRIT

During the second review of the Bangko Sentral ng Pilipinas’ (BSP) monetary policy last Monday, the Monetary Board decided on what was obvious. The BSP maintained its policy rate at a 16-year high 6.5 percent, the fourth since that off-cycle meeting in October 2023 that jacked up interest rate further by 25 basis points (bps).

Even if the readings for the first three months of the year averaged only 3.3 percent, well within the two to four percent inflation target for 2024 and 2025, their trend is rising. Thus, the BSP raised its baseline forecast for 2024 from 3.6 percent to 3.8 percent. Next year is expected to continue seeing an unchanged inflation forecast of 3.2 percent.

Two things should keep us worried over the inflation prospects.

First, upside risks continue to remain dominant: additional transport charges, elevated food prices, higher power rates and global oil prices. Proposals for minimum wage adjustment in Congress could materialize and further exacerbate such upside risks. This repeated reference to upward risks should now guide economists and market observers in avoiding talks about an early cut in the policy rate. At this point, it is not good to have, the risks are not diminishing and the numbers belie them.

Such upside risks anchor the BSP’s risk-adjusted inflation forecasts. When the risks are considered, we are looking at a higher 4.0 percent for 2024 and unchanged 3.5 percent for 2025. With higher external risks, the BSP Governor was right on the mark when he said “we’re a bit more hawkish than before…”

The Governor’s forward guidance is unmistakably direct. “If we see some good news in inflation and somewhat weak growth, we could ease by the third quarter. And if it’s the opposite, we would ease by the first quarter of 2025.”

All up, it’s difficult to make any bet on a third quarter easing.

The Governor’s statement was more than straightforward: “I would say if we were relatively dovish, we might reduce rates in the third quarter and that would be no more than 25 bps. But now we’re more hawkish. So, we are not going to do it by the third quarter.” This is clear as day.

While Meralco rates have been reported to be lower by just less than ₱1 per kilowatt hour this month, El Niño’s extreme heat scenario could easily produce drought in at least 41 areas from north to south of the Philippines. Supplies and supply chains are bound to suffer, and they could motivate still higher inflation. Yet the government is still talking about “pushing for area-specific ways of addressing the problems created by the El Niño phenomenon.” Yet we continue to hear public officials looking at the problems “by area” to come up with solutions to help affected farmers. El Niño is now in full swing; it’s not like a movie that is coming soon.

Second, inflation expectations risk being unhinged. The increasing momentum of actual inflation in the last two months was driven both by base effects and actual price pressures. These are key developments reported in various traditional and social media, keeping the civil society abreast. Second-round effects will likely be triggered, something that could also stiffen inflation expectations close to or outside the inflation target.

There is another factor that could compromise price stability.

The BSP Governor referred to rice prices as “salient prices.” These are prices that “get noticed, and they tend to affect expectations more than other commodities.” Even if the rest of the prices in the consumer basket have moderated, if rice prices continue to rage, as they do now due to low inventory and delayed arrival of rice imports, inflation expectations could be upset.

This phenomenon is no different from what the Bank for International Settlements (BIS) observed in 2022. The BIS argued that broadening price pressures may have caused households and firms to step out of the zone of “rational inattention” within which inflation may not have much influence on their behavior. They would tend to focus on the prices of just a few items.

In the case of Filipino households, they are more attentive to price movements of basic commodities especially rice, fuel prices and transport charges. Demand for higher wages and price adjustments could therefore lead to inflation becoming more entrenched.

If the market should wait until the Governor’s another condition is fulfilled, economic growth that is “not too strong,” a third quarter easing may indeed be a long shot. Last Monday’s AMRO presentation of the ASEAN + 3 Regional Economic Outlook (AREO) indicated a growth forecast for the Philippines of 6.3 percent in 2024 and 6.5 percent in 2025 due to better prospects for exports and investments. AMRO agreed that inflation has not come down enough for the BSP to feel confident easing the policy rate.

Finally, some analysts would also anchor the BSP’s easing action on the US Fed scaling down the fed funds rate. But US economists themselves are not one on the possible Fed rate cuts this year. Jobs data, price increases and the strength of the US economy appear inconsistent with the Fund’s announced three-quarter-point rate cuts in 2024.

Prudence remains a cardinal virtue. As US Fed Chairman Jim Powell stressed to the Stanford University Graduate School of Business last April 3, 2024, the outlook remains uncertain. It is risky for central banks to reduce rates too early or too late. Doing it prematurely might require a policy reversal because inflation could resurge. Doing it later with too little adjustment could unduly weaken the economy and employment. Principled waiting will result in a better balance of inflation and growth risks.

Meanwhile, it is best to go easy on the easing story.