The BSP announced today the publication of the 15th issue of the quarterly BSP Inflation Report covering the period July-September 2005. The full text of the Inflation Report was released today in electronic format (as a PDF file) and may be downloaded from the BSP website. A print version will be made available by end-November 2005. The BSP Inflation Report is being published as part of the BSP’s transparency mechanism under inflation targeting and to convey to the public the overall thinking and analysis behind the BSP’s decisions on monetary policy.
The following are the highlights of the BSP Inflation Report for the Third Quarter of 2005:
Inflation decelerated during the quarter amid easing supply-side pressures (particularly from food prices) and subdued demand-side pressures. Oil prices have continued to rise but food inflation has eased due to improved weather conditions, thereby allowing headline inflation to decelerate. On the demand side, some indicators continued to show improvements, but consumption spending has slowed based on latest available data for the second quarter. Moreover, bank lending remains subdued, while labor market conditions remained generally soft despite a modest decline in the unemployment rate. In addition, survey results were also mixed as consumers were less optimistic while businesses expected seasonally-related improvements in the last quarter.
Liquidity has remained ample in the financial system, and this has led to a continued decline in interest rates. Recent liquidity growth has been driven by continued appetite from banks for government securities as well as inflows from OFW remittances and portfolio investments. Amid modest growth in bank lending, primary auctions of government debt papers were met with excess bids. As a result, the bellwether 91-day T-bill rate fell in July and August, helped also by a decline in the risk premium as a result of improvements in fiscal conditions. However, the 91-day T-bill rate picked up slightly in September following the rise in BSP’s policy rates.
The foreign inflows in turn have also helped support the peso against the US dollar. The peso continued to appreciate in nominal terms, supported by sustained dollar inflows from overseas Filipino workers (OFW) and higher portfolio capital flows.
Global economic expansion remained broadly on track, led mainly by the US and China. The robust output of the services sector offset the slowdown in manufacturing activity while higher oil prices dampened consumer spending amid generally favorable labor market conditions. Inflation pressures at the global level appeared to be well- contained despite the observed uptick in inflation during the recent months. Forward-looking global economic indicators appear consistent with a moderate but solid growth performance in the year ahead. However, the continued rise in oil prices remains to be a major source of risk to the outlook for the rest of the year.
Policy responses of major central banks during the third quarter were generally cautious. The Bank of England's Monetary Policy Committee voted to keep the key repo rate at its current level of 4.50 percent during its September 2005 meeting, following a rate cut in August. Similarly, monetary authorities in the Euro area and Japan kept their monetary policy settings unchanged during their last policy meetings, to provide continued support to the ongoing economic recovery in their respective economies. Meanwhile, the US Federal Open Market Committee (FOMC) raised its policy rate by 25 basis points to 3.75 percent in its last meeting held on 20 September 2005, with the FOMC noting that policy accommodation can be removed at a pace that is likely to be measured.
For its part, the Monetary Board of the BSP tightened the policy stance during the third quarter to address the emerging risks to inflation. Measures included the increase in the reserve requirement ratios in July and the hike in policy rates in September. Given that the projected risks from cost-side pressures had intensified, monetary authorities tightened the policy stance to protect the inflation targets. The BSP also noted that the recent strong growth in liquidity could be a potential risk to inflation if unmatched by improvements in real sector activity.
Going forward, the main risks to the inflation outlook continue to be from the supply side. The BSP expects inflation to continue to ease until the end of the year. Thereafter, inflation will begin to gather pace and reach its peak in the first half of 2006, when the VAT rate is assumed to increase from 10 percent to 12 percent in January, as provided by the law. Thus, the BSP continues to expect above-target average inflation for 2005 and 2006.
Prevailing conditions and the outlook for inflation and output suggest a stronger case for a monetary response to inflation pressures. Cost-side pressures are expected to strengthen in the coming quarters, and the prospect of high oil prices and the implementation of the RVAT are expected to push up headline inflation in the first few months of 2007. The main risk from the outlook is the likelihood of further second-round effects (particularly nominal wage increases) and the potential threat to inflation expectations, since the public may begin to expect inflation to remain indefinitely at high levels.
The BSP will continue to assess the impact of its recent policy actions and carefully study the need for any possible adjustment of its policy stance. The extent of any additional tightening that will be undertaken by authorities will be balanced with the need to allow enough room for the economy to grow. Particular attention will be given to ensuring that the level of domestic liquidity remains consistent with the BSP’s price stability objective and that all other emerging risks to inflation and inflation expectations are equally addressed in a timely and appropriate manner.
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