Is the BSP gearing up for an interest rate hike this year?

MANILA, Philippines — The bets are on whether the Bangko Sentral ng Pilipinas (BSP) would finally take a hawkish stance on interest rates in 2018 after its dovish tones in the past three years to support the country’s expanding economy.

Majority of the financial institutions and economists are projecting a rate hike of between 25 basis points and 100 basis points as multilateral lenders and investment banks raised concerns of overheating of the economy.

However, others believe the country’s monetary policy setting remains appropriate, saying fears of overheating are unfounded, baseless and overdone.

The robust domestic economy and benign inflation environment have allowed the central bank to keep an accommodative stance through low interest rates to support the growing economy.

The Philippines has booked 75 quarters of uninterrupted growth with the gross domestic product (GDP) expanding by 6.9 percent in the third quarter from the revised 6.7 percent in the second quarter.

On the other hand, inflation averaged 3.3 percent in the first 11 months.

The BSP has set an inflation target of two to four percent between 2017 and 2020, but expects the consumer price index to settle within the midpoint of the target.

The last time the BSP’s Monetary Board adopted monetary tightening was in September 2014 as it raised benchmark rates by 25 basis points.

In all, the central bank raised interest rates by 50 basis points and the reserve requirement ratio for banks by two percentage points in 2014 to manage inflation risks.

Inflation accelerated to 4.1 percent in 2014 from three percent in 2013, falling within the three to five percent target set by the BSP.

Mixed bets

Euben Paracuelles, economist at Nomura, said it now expects inflation to average 4.3 percent instead of 3.9 percent next year, breaching the BSP’s two to four percent target.

He pointed out factors behind the revision include rising oil price to $65 per barrel as well as the impact of the Tax Reform for Acceleration and Inclusion (TRAIN) signed into law by President Duterte last Dec. 19.

As such, Paracuelles said the BSP would raise its policy rates by 100 basis points with a 25 basis point hike per quarter.

“We think the BSP will not be able to look through the risk of headline inflation breaching its target in 2018. As a result, we now expect BSP to hike its policy rate by a total 100 basis points to four percent at a rate of one 25 basis point hike per quarter,” he said.

UBS senior ASEAN economist Edward Teather expects inflation to accelerate to 3.8 percent next year before easing to 3.4 percent in 2019 as the tax reform package would yield an administrative increase to consumer prices.

“Due to our above-consensus inflation outlook, and the outlook for Fed rate hikes, we foresee a 75-basis point rate hike from the BSP in 2018, followed by another 50 basis points in 2019,” he said.

HSBC economist Noel Arbis said there are signs of demand-pull inflation as there are upside risks for 2018 due to rising oil, electricity, and food prices, prompting the central bank to increase rates in 2018 instead of 2019.

“Most importantly, there may be signs of demand-pull inflation. We have thus moved up our expectation for a rate hike from first quarter 2019 to second quarter 2018 and raised our inflation forecast to 3.4 instead of 3.3 percent in 2018 to reflect these risks,” he said.

The economist said HSBC believes it would be a shallow hiking cycle and done only to moderate inflation pressures and close the gap between the average weighted average of the term deposit rates.

It expects another rate hike to come in at the third quarter of 2019.

However, Arbis said the BSP’s next move would be at least a 100 basis point cut in the reserve requirement ratio as the central bank continues the transition to the interest rate corridor (IRC) framework.

On the other hand, Capital Economics economist Gareth Leather said the BSP would likely keep interest rates unchanged in 2018 as overheating fears are overdone.

“We think such fears are overdone, with inflation moderating we expect BSP to leave rates on hold both this year and next,” he said.

Gareth said fast economic growth on its own does not mean the economy is overheating while credit growth, while fast, is concentrated in productive investment that would actually improve the capacity of the economy over the medium term.

“Accordingly, we are skeptical that the economy is overheating and the BSP need to take action,” Leather said.

Fears misplaced

For his part, BSP Deputy Governor Diwa Guinigundo said overheating concerns are misplaced.

He explained the economy has been growing at an incredible pace with 18 years of consecutive and uninterrupted growth accompanied by a substantial rise in credit growth of 19.9 percent in October from 21.1 percent in September.

“This growth story of 75 consecutive quarters demonstrates how income and economic growth does not have to come as magic,” he said.

Overheating occurs when an economy’s capacity to supply goods and services is not able to keep up with demand. During an economic boom, overheating materializes when there are high levels of aggregate demand that exceeds what suppliers can produce on a long-term basis.

In short, overheating is seen when output rises unreasonably above its potential level, followed by unanticipated acceleration in inflation due to prolonged high growth rate.

“This is certainly not the case for the Philippines,” Guinigundo said.

Guinigundo said credit expansion is accompanied by solid economic growth but the rise in lending activity has been based on solid demand for loans across key economic sectors and households.

The country’s credit-to-GDP ratio of 63.6 percent remains one of the lowest in the region, second only to Indonesia’s 40.6 percent.

Race car analogy

BSP Governor Nestor Espenilla Jr. said monetary authorities are working hard to run the economy competitively to finish as a winner.

“We are talking careful preparation, regular tune-ups and upgrades, skillful driving, and constant monitoring. The engine is expected to get hot along the way. That’s what running engines do,” he said.

The BSP chief said there is a huge difference between a hot engine and an overheated engine.

“If we don’t like hot engines, we should keep our car parked,” he said.

Debt watchers Fitch Ratings and Moody’s Investors Service, multilateral lender International Monetary Fund (IMF) as well as economists of various investment banks have flagged possible overheating of the economy.

Espenilla said monetary authorities are always ready to step in to prevent the possible overheating of the economy.

“I can tell you that BSP spends a lot of time understanding the economy at any given point of time, developing a dynamic game plan, and executing effectively. So the economy doesn’t overheat,” he said.

The policy toolkit of BSP, he said, is not just monetary policy since it has considerable supervisory powers over the banking and financial system to prevent imprudent and reckless behaviors in individual entities and sectors that lead to unsustainable risk build ups.

BSP to keep rates untouched, us other toolkit

Despite the consensus, the BSP is seen keeping interest rates unchanged in 2018 despite the possible three rate increases by the US Federal Reserve to match the three rates hikes in 2017.

“Our monetary policy is independent of what the Fed does. We’re not obliged to follow since we don’t have fixed exchange rate. Instead, our primary focus is on the inflation outlook relative to our target,” Espenilla said.

The BSP shifted to the inflation targeting framework in 2002 to focus on its primary objective of the central bank’s monetary policy to promote price stability conducive to a balanced and sustainable growth of the economy.

The framework is focused mainly on achieving a low and stable inflation, supportive of the economy’s growth objective.

Instead, the BSP is seen using other toolkit to keep inflation manageable over the policy horizon as it pursues the reduction of the reserve requirement ratio in tandem with the adoption of the Philippine roadmap for developing the local debt market.

Keeping interest rates steady at low levels would allow companies to expand further and boost private consumption, fuelling sustained economic expansion.