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BSP Raises Key Policy Rates

10.20.2005

At its meeting today, the Monetary Board decided to increase the BSP’s policy interest rates by 25 basis points to 7.5 percent for the overnight borrowing or reverse repurchase (RRP) rate and 9.75 percent for the overnight lending or repurchase (RP) rate.

The Monetary Board noted that the latest BSP forecasts, which incorporate more recent data on inflation, output and other key variables, indicate a possible breach of the inflation target in 2007, due to possible second-round effects coming from supply-side pressures.  Equally important, the possibility of a sustained deviation of the forecast from the target over the policy horizon poses a considerable risk to inflation expectations, in that the public may begin to expect inflation to remain persistently well above announced government targets.  Because monetary action normally requires 15-21 months to take full effect on inflation, policy measures undertaken now will help address the risks to inflation and inflation expectations in the coming year and in 2007. 

An added concern is the continued rapid growth in domestic liquidity. Available data suggest that the financial system remains very liquid despite the recent increase in the policy rate and the reserve requirements, and that the additional liquidity in recent months has been fueled by both foreign exchange inflows and by the deposit generation activities of banks. 

In summary, the Monetary Board believes that the need for a timely response to expected pressures, the risk of a sustained breach of the inflation target and the continued presence of excess liquidity in the financial system, provide the impetus for monetary action.  Recent policy moves have contributed to making the overall policy stance less accommodative. However, the evidence suggests that this action was necessary.  This monetary action will not only address the risks to inflation and inflation expectations but also clearly demonstrate the BSP’s commitment to its price stability mandate

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