Economists expect the Bangko Sentral ng Pilipinas to raise the benchmark policy rate by 50 basis points to 2.75 percent in its meeting next week after the US Federal Reserve adjusted its rate by 0.75 percentage point on Wednesday, the biggest increase since 1994.
Bank of the Philippine Islands said in a report Thursday that hiking the policy rate gradually in contrast to what the Fed was doing “might exacerbate the headwinds affecting the Philippine economy.”
“We now expect a 50 bp hike from the BSP in its June meeting given the latest move of the Fed… A very narrow gap between US and local interest rates will likely exert more pressure on the peso, which will eventually translate to more inflation,” the bank said.
BPI said consumer prices would likely be more sensitive to exchange rate movements as the economy was becoming more reliant on imported products like oil, rice and pork.
“A higher inflation print in the future may force the BSP to do bigger rate hikes and even inter-meeting rate hikes that may cause volatility in the markets,” the bank said.
BPI said the gross international reserves would also become more vulnerable if the BSP would not hike rates more aggressively.
“We expect a substantial decline in foreign reserves in this scenario as the BSP will have to sell dollars in order to temper the depreciation caused by the narrowing interest rate differentials,” it said.
BPI said that if this happened, the country’s credit rating might be put at risk as the country’s strong external position is one of the reasons why rating agencies did not downgrade the Philippines, especially during the pandemic. It said it would become more challenging for the government to manage its finances if the credit rating was downgraded.
“With GDP growth at 8 percent and unemployment rate below 6 percent, the economy has enough cushion to absorb the rate hikes. Historical experience has shown that the economy can grow by at least 6 percent in an environment where the policy rate is around 3 to 4 percent,” it said.
Michael Ricafort, chief economist of Rizal Commercial Banking Corp., said aside from having a high chance of a 50-bps hike in policy rate on the June 23 meeting of the Monetary Board, “more local policy rate hikes for the rest of the year” could be expected.
Ricafort said this is “partly to maintain a comfortable interest rate differential with the US, to account for the comfortable spreads/interest rate differentials/risk premium—a dilemma faced by many other countries/central banks around the world”.
“For instance if the Fed Funds Rate reaches as much as 3.4 percent by end-2022 and to about 3.8 percent by end-2023, as suggested by the Fed/FOMC Dot Plot and as consistently being priced in recently by the financial markets, the local policy rate could potentially increase further to at least 3 percent to 4 percent levels to maintain healthy interest rate differentials with the US given the differences in credit ratings and inflation outlook for the coming years,” Ricafort said.
Ricafort said that as the US remains the world’s biggest economy, the resulting risk of economic slowdown or recession could also slow down the economy of many countries around the world, in terms of reduced global trade, investments, employment and other business/economic opportunities on the hopes to bring down elevated US inflation close to the target of 2 percent.
The Federal Open Market Committee of the Federal Reserve raised its Fed Funds Rate target by 75 bps on Wednesday to 1.50 percent to 1.75 percent. This is the biggest increase that the central bank has done since 1994.
Citing the latest dot plot, BPI said Fed officials now expect the Fed Funds Rate to end the year at 3.4 percent and then at 3.8 percent in 2023.
The BSP’s Monetary Board on May 19 hiked by 25 basis points the record-low 2 percent policy rate to 2.25 percent to rein in inflation rate amid the continued economic recovery from the impact of the COVID-19 pandemic.
