BSP poised for more rate hikes — Medalla

Bangko Sentral ng Pilipinas (BSP) Governor Felipe M. Medalla said there will be more policy rate increases this year to bring down inflation to below four percent in November or December, or at the very latest, by January 2024.

Medalla said that while the economy’s growth trajectory is expected to slow down this year as it absorbs BSP’s higher rates, he has become more confident that they have been “quite successful” in curbing “knock-on” effects or second-order effects on inflation’s supply shocks.

“The question you might ask: won’t our [tight] monetary policies slow down the economy significantly? Our own calculations is it will slow down the economy but not significantly. One of the reasons, of course, is that, although the policy rate is 6 percent, our forecast [full-year] inflation, if it happens at the end of the year, will be about 4 percent, then in reality, the real [inflation-adjusted] interest rate is just 2 percent,” Medalla told a recent Lower House hearing on the latest Development Budget Coordinating Committee (DBCC) inflation-related assumptions.

The BSP’s Monetary Board raised the overnight borrowing rate by another 50 basis points (bps) last Feb. 16 to six percent. On the same day, the BSP adjusted its 2023 inflation forecast higher to 6.1 percent versus the target of two percent to four percent, while next year’s forecast is 3.1 percent.

For 2023, the BSP expects the economy could still grow by six percent to seven percent versus 7.6 percent in 2022. Other forecasters including the International Monetary Fund has a lower growth projection of just five percent while the Asian Development Bank forecasts six percent.

“The point is, the economy, even after adjusting for inflation, after removing the effects of inflation on values, we’re actually seeing the economy grow by 7.6 percent last year to 6 percent this year,” said Medalla. He again reiterated the importance of targeted assistance and non-monetary measures.

Meanwhile, Medalla has signalled to the market that they will again raise the key rate by another 25 bps on March 23.

He told the Lower House that “although I’m not promising there will be no more rate increases (we) have largely contained ‘knock-on’ effects, second-order effects of inflation.”

The “worst” scenario is that inflation will only come down to within the target range by January next year. This would indicate that inflation will remain above-target for 19 to 20 straight months. Previously, the longest was 15 straight months.

“Our forecast is that inflation will be above target for 19-20 months which means inflation will be below 4 percent maybe by November or December at the earliest. (But) what’s worrisome is, although our forecast for 2024 is closer to 3 percent than to 4 percent, the private sector forecast is 4 percent. We call this ‘disanchoring of inflationary expectations.’ People expect higher prices. Therefore, they raise prices,” said Medalla.

Fortunately, Medalla said the exchange rate is now relatively in favor of the peso. After the Feb. 16 rate hike, the peso is again below P55 to the US dollar, and appreciated by one percent in January.

The greenback has weakened following the US Federal Reserve’s signal that there will be no more large increases such as the four 75 bps they had in 2022.

“We’re doing our best,” Medalla told the Lower House. “We think we will succeed in making sure that we do not have a self-fulfilling prophecy of high inflation: inflation is high because it’s high and it will be higher.”

Food and non-alcoholic beverages are the biggest contributors to inflation. Medalla said that right now, the pressures on prices are broadening.

“To put it bluntly, higher prices could beget higher prices. Of course, the scary part is what they call a ‘wage-price spiral’: prices are high, wages are high, prices are high[er], wages are high[er]. To make matters worse, if that also results [in a vicious cycle where] prices are high, the peso is weaker, weaker peso, higher prices. Then, we will really be in trouble,” he said.