BSP unlikely to cut key rate ahead of the Fed

To avoid FX volatility

The Monetary Board, the central bank’s policy-making arm, is not expected to reduce its benchmark rate ahead of the US Federal Reserve as this might lead to sharp exchange rate fluctuations, according to analysts.

“We don’t think the BSP (Bangko Sentral ng Pilipinas) would be able to cut ahead of the Fed without leading to much volatility in the peso, which is a risk to inflation in itself,” said HSBC Global Research.

Citi economist for the Philippines Nalin Chutchotitham said the same thing, adding that while the BSP is closely monitoring US interest rates, it is also focused on domestic conditions for sometime.

She noted that BSP “continued to express no special concern on recent FX (foreign exchange) movements. While not giving specific numbers, the BSP said its assumption on USDPHP for economic forecasts is within the government’s target 55-58 band.”

The peso vis-à-vis the US dollar has been ranging between the P55 level and P56 level for weeks. It will briefly touch P56, only to appreciate the next day back to the P55 range.

Chutchotitham predicts BSP will likely start its dovish cycle by the third quarter this year. She further noted that the first rate cut will be on Aug. 15 and thereafter, “the BSP likely (will) deliver gradual reductions in 25bp pace until its reaches 5.50% at end-2024.”

“As of now, economic momentum appears strong enough to not warrant aggressive rate cuts. At such pace, the BSP would also have time to assess the market’s reactions to the Fed’s policy easing later this year as well, thus not adding unnecessary pressures on the PHP (peso),” she added.

HSBC expects the Fed will start reducing its own interest rates by June this year. It said it is likely the BSP will follow suit with a similar rate cut when the Federal Open Market Committee – the Fed’s branch that decides policy stance – will make such a move.

“Our baseline view is for the Fed to begin its easing cycle in June this year. And we expect the BSP to follow the Fed, cutting its policy rate thereafter,” the British bank reiterated in its latest commentary.

The central bank tries to maintain an interest rate differential of 100 basis points (bps) to 150 bps between the FOMC rate and the BSP rate to remove volatility pressures from the exchange rate spot market.

The BSP policy rate is still at 6.5 percent. The BSP’s Monetary Board decided to hold it at the same target reverse repurchase (RRP) rate on Feb. 14, announced as scheduled on Feb. 15. This was the third policy meeting in a row that the key rate has been left untouched.

The last policy rate adjustment was an off-cycle 25 bps increase on Oct. 26, 2023 to curb supply-side price pressures which could lead to additional second-round effects and thus further dislodging inflation expectations.

“We think the risk of an early rate cut is quite limited,” said HSBC. It reiterated what it said previously that BSP has luxury of time to wait it out and to “keep its policy rate tight long enough to see inflation really moderate to where the BSP wants it to be.”

Two factors have put BSP at ease as it remained on a hold stance: the relatively better than expected gross domestic product (GDP) growth performance in 2023 and the decelerating inflation.

“Headline CPI (consumer price index) is already well-within the BSP’s 2-4% target band at 2.8% y-o-y (year-on-year) while the central bank has lowered its risk-adjusted CPI forecast in 2024 to 3.9%, which is within the BSP’s 2-4% target band,” said HSBC.

It further noted that the “BSP kept its policy rate steady as it waits for more data before being fully convinced that inflation has been nipped in the bud. In fact, year-on-year inflation is expected to rise due to base-effects alone, and it can take one big upside risk to inflation to materialize for headline CPI to breach the central bank target yet again.”

During the BSP’s policy meeting this week, the Monetary Board revised lower its risk-adjusted inflation forecast to 3.9 percent from 4.2 percent (Dec. 14, 2023 meeting).

For 2025, the risk-adjusted inflation forecast is 3.5 percent, slightly lower than the previous 3.4 percent estimate.

BSP Senior Assistant Governor Iluminada T. Sicat told reporters Thursday that risks to the inflation outlook have receded but are still persistently on the upside.

Risks to the inflation forecasts are higher transport charges; increased electricity rates; higher oil and domestic food prices; and the additional impact on food prices of a strong El Niño episode.

Meanwhile, most market analysts anticipate the BSP will reduce its key rate in the second half of 2024, to mirror an expected Fed action.

Sicat said that if the risks to the inflation outlook will be reduced further, and also the path of actual inflation decelerates as what happened in December 2023 and January 2024, “there might be consideration to change the monetary policy stance.” The last two consumer price index reports were below four percent or within the target range of two percent to four percent. — Lee C. Chipongian