Neutral policy rate for Philippines slashed to 5%

MANILA, Philippines — The economic scarring effects from the pandemic, expected to be worst in the Philippines, are seen bringing down the country’s long-term neutral policy rate, an international think tank said.

In its latest research brief, London-based Oxford Economics lowered the country’s long-term neutral policy rate to five percent from its previous 5.5 percent forecast as the COVID-19 pandemic leaves the Philippines with deep economic scars.

The think tank said the Philippines would likely suffer the worst effects from the pandemic in the Asia Pacific amid its meager fiscal response and difficulty in containing new waves of the virus.

Oxford said the long-run nominal neutral policy rate – the rate at which the economy is in equilibrium and monetary policy fully normalized – to settle at five percent or 50 basis points (bps) below its pre-pandemic projections.

“The recalibration of our neutral rate forecasts primarily reflects the long-term impact of the pandemic on our forecasts for potential GDP growth,” Oxford lead Asia economist Sian Fenner said.

“A lower policy rate in the medium term will necessarily feed into lower long-term yields, and we now expect the 10-year government bond yield to settle at around 6.8 percent, some 80 bps lower than previously,” she said.

The neutral rate is also consistent with full employment and inflation at the Bangko Sentral ng Pilipinas target and is closely linked to the pace of economic growth.

Further, Oxford maintained that the transition to the neutral rate would be more moderate than previous rate-tightening cycles as it would take longer to unwind the 9.6 percent economic contraction last year.

Fenner argued that the country’s improved external position also supports a gradual pace of normalization, providing a buffer even if market expectations of US rate hikes increase.

And if the Philippines’ policy rate were to rise significantly above the federal funds rate, the peso would appreciate, damaging the economy’s competitiveness and dampening output, “something we think policy makers will be keen to avoid,” Fenner said.

Despite the latest forecast, Oxford said its outlook on monetary policy is unchanged and that is for the policy rate to remain at two percent until end-2022 to aid in economic recovery.

This, as headline inflation continues to hover above the BSP’s two to four percent target since January. Oxford said such a trend would continue in the next quarters as global prices are still soaring.

This is also despite easing food inflation amid effects of more imported volume and lower tariffs for pork imports.

With inflation also set to remain comparatively higher in the Philippines relative to other developing economies and most of Asia, “we expect its neutral policy rate will still be substantially above those in the US and other Asia Pacific economies,” Fenner said.

Nonetheless, Oxford still expects the Philippines to be one of the fastest growing economies in the region and globally.

“Although we expect the contribution from labor to soften over the long term, the Philippines will continue to benefit from the so-called ‘demographic dividend’ that is the boost to growth from labour supply growing faster than the dependent population,” she said.