The Bangko Sentral ng Pilipinas (BSP) is not expected to adopt an aggressive stance when it starts with the rate cuts possibly next month due to some limiting factors such as the exchange rate and the country’s external position, according to analysts.
In a commentary, Bank of the Philippine Islands (BPI) analysts said they still think the BSP’s Monetary Board will reduce the 6.5 percent target reverse repurchase (RRP) or the policy rate on Aug. 15 after the government announced a lower inflation of 3.7 percent in June versus 3.9 percent in May.
“The BSP may start cutting interest rates in August, although aggressive rate cuts are unlikely due to domestic and external constraints. This move may lead to a steepening of the yield curve, with a more pronounced impact on the short end compared to the long end of the curve,” said BPI.
BSP Governor Eli M. Remolona Jr. himself has said that they are looking at a 50 basis points (bps) rate cuts this year, possibly in August and by Oct. 17 or Dec. 19.
Metrobank Research, meanwhile, is predicting the BSP will start reducing the policy rate in the fourth quarter or Oct. 17 by 25 bps and then another 25 bps on Dec. 19 to support the exchange rate currently at the P58 level vis-à-vis the US dollar.
BPI economists said it is more likely the BSP will cut the policy rate first in August because for the bank, the inflation rate may have already peaked in June. Metrobank analysts said a rate cut is possible in August only if the July inflation will “surprise on the downside” or be lower than the June data.
For BPI analysts, a rate cut in August is a potential trade-off for the peso as this could lead to a depreciation since the interest rate differential will shrink between the US Federal Reserve rates and the BSP rates. This could add pressure on the spot market and increase the exchange rate volatility.
“However, it seems this is a trade-off that the BSP is willing to tolerate for now. The pass-through from the exchange rate to inflation appears to be manageable based on the analysis of the central bank, and will only become a concern if the inflation target is at risk again,” said the Ayala-led bank.
A weaker peso would still be a limiting factor “that will likely prevent the BSP from cutting interest rates aggressively, especially given the current account deficit that the country has,” it added.
As such, BPI analysts expect the peso may weaken further in the near term, with pressure from the narrowing interest rate differential between the US interest rates and domestic rates. “It may recover towards the end of the year if the Fed decides to cut its interest rates. However, while a Fed cut might lead to peso appreciation, its gains are likely to be smaller compared to other emerging market currencies given the substantial current account deficit of the country,” said the bank.
Besides the exchange rate, the country’s external position is another reason why the BSP will not take to aggressive rate cuts. As of end-May, the balance of payments is in surplus of almost $1.6 billion but the current account is still in a shortfall of $1.7 billion as of end-March. The external debt is high at $128.69 billion as of end-March against the BSP’s dollar reserves of $104.7 billion as of end-June.
“The foreign debt of the country has been growing faster compared to its foreign reserves, resulting to a lower FX (foreign exchange) reserves to debt ratio. Cutting interest rates aggressively would make the build up of FX reserves more challenging, which may lead to a further deterioration in the external position,” said BPI analysts.
“Aggressive rate cuts are unlikely given the prevailing inflationary environment,” it further noted, adding that “global supply constraints and geopolitical tensions are contributing to a faster rise in prices compared to the past decade, limiting the BSP's room for significant rate reductions.”
BPI analysts also argued that BSP will choose to gradually reduce the target RRP rate to allow it more room to also reduce banks’ reserve requirement ratio (RRR).
“Over the years, the BSP has refined its market-based monetary tools, which financial institutions actively use in managing their liquidity. We expect that these tools will be effective in absorbing the excess liquidity generated by the reduction in the reserve requirement. This is also one of the reasons why we expect a gradual decline in the policy rate, as this would allow the BSP to cut the glaringly high RRR at the same time,” said the bank.
Remolona said previously they could reduce the RRR to a low of five percent from its current 9.5 percent but the timing is crucial and not when the BSP is still on a hawkish stance.
In Asia, the Philippines’ RRR is considered one of the highest. An RRR cut is not considered a change in monetary policy stance but is merely an operational adjustment on the part of the BSP.