Analysts at the Metropolitan Bank and Trust Co. anticipate another pause in the cycle of policy rate adjustments when the monetary board of the Bangko Sentral ng Pilipinas (BSP) convenes at the rate-setting meeting next week on 22 June.
This means the rate at which it borrows from the banks, effectively the rate where all household and business loans are pegged plus a spread, remains at 6.25 percent.
According to Metrobank, the BSP whose mandate is keeping inflation within target of 2 to 4 percent, is managing price pressures at less elevated levels in recent months as headline inflation steadily slowed from a recent peak of 8.7 percent in January to 6.1 percent in May on the back of lower transport costs and normalizing oil and food supply prices.
“Here at home, headline CPI slowed for the fourth straight month in May to 6.1 percent from April’s 6.6 percent on the back of lower transport costs and normalizing oil and food supply prices. This steady decline in inflation has led the BSP to lower its average inflation forecast in 2023 from 6 percent to 5.5 percent,” Metrobank noted.
Its analysts argued that unlike the US Federal Open Market Committee or US Fed whose focus on inflation was temporarily sidetracked by debt negotiations, the BSP is presented with an inflation outlook far less sticky than that presented its US counterpart.
“After narrowly skirting the debt ceiling crisis in early June, US authorities can focus back on the inflation problem. On its policy meeting today (Thursday), however, it made a pause on hiking its rates, but surprised with a forecast of two more quarter-point hikes in its economic projections this year. Federal Reserve Chair Jerome Powell also noted that inflation remains elevated and this month’s decision is only a pause that will allow the body to further analyze incoming data. He also signaled that a large majority of the FOMC expects additional tightening in its next meetings,” its analysts said.
The policy adjustment has bearing on the so-called interest rate differential (IRD) the change of which has impact on the exchange rate and on foreign investments entering or leaving the country.
“Over the last 10 years, the IRD in policy rates between the two currencies averaged 200 basis points, but this has now tightened to 100bps. Markets are therefore concerned that tighter interest rate differential at the policy rate level could result in portfolio outflows, leading to a weaker Peso.
“Metrobank’s analysis, however, suggests that the USD/PHP rate is not solely influenced by central bank’s policy rates, which are overnight rates. Metrobank found that historically, the USD/PHP exchange rate also depends on two other factors, one, the IRD between the 10-year Peso government securities and US Treasury Bonds and two, the level of the Philippines’ Gross International Reserves (GIR).
“When comparing 10-year Philippine and US bond yields, the IRD between the two currencies has remained well- above 200bps and much closer to its 10-year historical average of around 250bps. The yield premium helps attract foreign portfolio investors to long-term peso government securities, which tempers selling pressures on the Peso, especially now that both the BSP and Fed are at or near the end of their rate hiking cycles,” Metrobank analysts said.
According to its analysts, the country’s foreign currency reserves remain strong at $101.76 billion and sufficient to support the local currency the peso and manage attendant volatilities.
“This means that even if the IRD between the overnight policy rates of the BSP and Fed were to tighten to 75bps, Metrobank believes that the USD/PHP exchange rate will not approach the record highs of P59/USD seen last November 2022, which was driven by the aggressive Fed rate hikes.
“Due to concerns of a deeper economic slowdown and regional banking issues in the US, the Fed has signaled that it’s near the end of its hiking cycle, and with the still-wide IRD in long-term Peso and Dollar government bonds, the pressure on the Peso exchange rate has eased. The market is currently forecasting USD/PHP to possibly trade beyond the 56-level over the next few months as importations pick up in line with seasonality, before moving back lower towards year-end when OFW remittances traditionally flow into the country.
“Given these, Metrobank therefore believes the BSP may no longer need to match every policy move of the US Federal Reserve, as it did in the latter part of 2022,” Metrobank analysts said.
