BSP surprises with massive rate hike to choke off rapid inflation

Ian Nicolas Cigaral - Philstar.com

MANILA, Philippines (Updated 12:24 p.m.) — The Bangko Sentral ng Pilipinas hiked its key rate by massive 75 basis points (bps) at an off-cycle meeting on Thursday, in a bid to rein in rapid inflation and arrest the peso’s slump.

The jumbo rate increase was preceded by two rate hikes cumulatively worth 50 bps in May and June. The BSP’s policy rate now stands at 3.25%, back to March 2020 level and reversing all of the central bank’s pandemic-era rate cuts.

This is the BSP’s most forceful tightening since it formally adopted the interest rate corridor (IRC) system as a framework for conducting its monetary operations in 2016. Before this, the last aggressive action from the BSP was recorded in July 2008, when it jacked up rates by 50 bps.

At the same time, this is the BSP's first unscheduled move since holding an off-cycle meeting on April 16, 2020 to cut rates and support the pandemic-hit economy. The Monetary Board was not supposed to hold its policy meeting until August 18 and the BSP had originally planned to lift rates by 50 bps when that day comes.

As it is, the BSP’s surprise decision came over a week after the release of data showing inflation sizzling to 6.1% in June, the hottest in more than three years and soaring past the government’s 2-4% target.

The move also came after last night’s data showed US inflation hit a new four-decade high of 9.1% in June, fueling bets that the US Federal Reserve may fire off a supersized rate hike of 100 bps at its meeting later this month.

Contrary to the Fed, which has delivered mega rate hikes amid criticisms that it acted too slow on US inflation, the BSP had initially taken a less aggressive stance and lifted rates by only 25-bps at its May and June meetings to gently slow the economy and cool inflation.

But analysts have said the dissonance between the BSP and Fed’s policies has been weighing on the peso, which has sunk to 17-year lows. A falling currency is only exacerbating inflation in the Philippines by making imports more expensive at a time of rising global energy prices.

“It’s more than enough for now to calm the markets. Also it won't necessarily hurt the economy. We've lived and done well with much tighter policy settings for nearly a decade,” Jun Neri, lead economist at Bank of the Philippine Islands, said.

“I believe they have the flexibility to hike again in their August 18 meeting,” Neri added.

But more importantly, BSP Governor Felipe Medalla explained that today’s surprise hike was meant to convince Filipinos and the market that the central bank is serious in fighting inflation. This is because if Filipinos anticipate that prices will remain elevated in the coming months and years — or, in the BSP’s words, if inflation expectations were “disanchored” — people might call for bigger wages. This, in turn, may force businesses to increase their selling prices from time to time to offset the costs of pay hikes, potentially creating a dangerous cycle of rapid inflation that would be harder to control.

"By taking urgent action, the Monetary Board aims to anchor inflation expectations further and temper mounting risks to the inflation outlook. In particular, policy action is intended to help manage spillovers from other countries that could potentially disanchor inflation expectations," Medalla said in a statement.

“The Monetary Board noted that favorable conditions arising from the strong rebound in growth thus far in the year suggest that the domestic economy can accommodate a further tightening of monetary policy settings,” he added.

For Nicholas Mapa, senior economist at ING Bank in Manila, Medalla will need to sustain the recent hawkish rhetoric to re-anchor inflation expectations and establish commitment to fighting inflation. 

“We expect BSP to hike again at least one more time in 3Q with the possibility of further tightening should inflation continue to remain stubbornly high. Peso will get an immediate reprieve in the short term but chronic trade deficits could mean that any peso rally may be capped,” Mapa said.

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