BSP move to raise banks' reserves not enough to contain inflation

MANILA, Philippines - Zurich-based Credit Suisse believes that the decision by the Bangko Sentral ng Pilipinas (BSP) to raise the banks’ reserve ratio last week is not enough to contain additional inflationary pressures.

Credit Suisse vice president Devika Mehndiratta said in a research note that inflation is expected to continue to trend up and become a big issue.

Last June 16, the BSP decided to keep interest rates unchanged but raised the reserve requirement for banks to 20 percent from 19 percent to siphon off at least P38 billion in excess liquidity in the financial system as part of efforts to counter any additional inflationary pressures from excess liquidity.

“We doubt that means an end to the rate hike cycle. And that’s not because we expect inflation to become a big issue,” Mehndiratta said.

The BSP raised interest rates by 25 basis points last March 24 and by another 25 basis points last May 5 as a preemptive move to keep inflation expectations well anchored amid escalating oil prices in the world market. This brought the overnight borrowing rate to 4.50 percent and the overnight lending rate to 6.50 percent.

Inflation last May surprised on the downside as the market was expecting consumer prices to breach the higher end of the BSP target of three percent to five percent this year.

Inflation climbed to a 13-month high of 4.5 percent in May from the revised 4.3 percent in April bringing the average inflation in the first five months of the year to 4.2 percent.

Mehndiratta said Credit Suisse sees inflation trending up but would not hit “worryingly high” as it did in 2008 or during the height of the global financial crisis.

The lower than expected inflation rate last May gave monetary authorities enough elbow room to keep interest rates unchanged as latest baseline forecasts show a lower path and that inflation expectations have shown some signs of leveling off.

Mehndiratta said Credit Suisse sees the BSP further raising interest rates by another 50 basis points this year and hiking the reserve requirement for banks back to the pre-crisis level of 21 percent from 19 percent.

“We continue to expect another 50 basis points in interest rate hikes and possibly another 1 percentage point hike in the reserve ratio for 2011,” the economist stressed.

Mehndiratta said policy rate increases are unlikely to mean much for short-term rates unless liquidity in the financial system is reduced.

“In our view, the BSP would not want to be in a situation where it is confronted with the task of suddenly shocking the system with large rate increases in the event that we are faced with say, a sizeable inflation shock few months down the line,” the economist added.

The BSP slashed its key policy rates by 200 basis points between December 2008 and July 2009, bringing the overnight borrowing rate to a record low fourpercent and the overnight lending rate at six percent to cushion the impact of the global financial crisis on the domestic economy.