Long Iran war may force BSP to hike rates aggressively

THE RISK of inflation rising faster than expected and hitting double-digit pace as the Middle East war drags on may push the Bangko Sentral ng Pilipinas (BSP) to keep tightening to quell spiraling prices that could stymie economic growth, an economist said.

“The BSP’s imperative is to stay ‘ahead of the curve’ by keeping inflation expectations anchored and preventing spillover inflationary impacts on other core expenditure categories that would be even more damaging to medium-term growth,” Eugene Lee, associate director and economist for ASEAN and Australia at Hong Kong-based investment bank CLSA, told BusinessWorld on Friday.

Mr. Lee, also a former senior economist at the Monetary Authority of Singapore, sees Philippine inflation leveling off at around 8% under their best-case scenario, where a gradual deescalation in the conflict keeps global oil prices at an average of $100-$110 per barrel.

However, if the war drags on and tensions reignite, the headline print could surge to around 10%, he said. “The worst-case scenario sees the ceasefire failing to hold, leading to a re-escalation of the conflict and a continued blockade of traffic through the Straits of Hormuz for two to three more months. This exhausts alternative sources of oil reserves and prices could reach $120-130 per barrel.”

“Our expectation of BSP’s tightening cycle depends on how the conflict unfolds. In the best-case scenario, we expect three more rate hikes to 5.25%. In the worst-case scenario, we expect the policy rate to rise to 6%,” Mr. Lee said.

Philippine inflation has quickened rapidly since the Middle East war erupted in late February, printing at 4.1% in March to breach the BSP’s 2%-4% tolerance band. It further accelerated to an over three-year high of 7.2% in April as high global oil prices drove up costs of food and utilities in the country.

In response, the Monetary Board on April 23 delivered its first hike in over two years, raising the policy rate by 25 basis points (bps) to 4.5% as a preemptive measure to temper the spillover effects of rising oil prices and ensure inflation expectations remain anchored.

BSP Governor Eli M. Remolona, Jr. has also left the door open to further tightening via a succession of modest hikes to help combat surging prices

Mr. Lee said the central bank has room to tighten by 75 bps to 150 bps more, adding that the next rate increase could come even before the Monetary Board’s next scheduled review on June 18, depending on the developments of the Middle East conflict.

“The odds of an inter-meeting rate hike are high. During the past policy briefing, the BSP used the term ‘measured’ to reference 25-bp rate hikes and said that the impact of smaller 25-bp hikes was less detrimental to growth than a 50-bp hike. If inflation continues to surprise on the upside and the BSP sees a need for 50-bp hikes at the subsequent policy meeting in June, it could opt to break it into two 25-bp hikes in May and June,” he said.

“While the economic backdrop is weak, there is really nothing that the BSP can do to stimulate the economy in the short run. Given that the risks are skewed towards higher inflation, it is better to worry about inflation first, and growth later.”

The Philippine economy grew by just 2.8% in the first quarter versus 3% in the previous quarter and 5.4% a year ago. This is well below the government’s 5%-6% goal.

Mr. Lee added that the peso could breach the P62-a-dollar mark in the near term due to lingering risk-off sentiment as the oil crisis widens the country’s trade deficit through higher import costs.

“Tightening monetary policy strengthens the peso modestly but may not be able to offset the depreciation factors.”

The peso fell to a fresh all-time low of P61.721 against the dollar on Friday. — Katherine K. Chan