We are pleased to announce today the publication of the thirteenth issue of the quarterly BSP Inflation Report covering the period January-March 2005. The full text of the Inflation Report has been 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-May 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 First Quarter of 2005:
Inflation continued to rise in the first quarter of 2005. Inflationary pressures in the first quarter continued to be dominated by the impact of supply-side factors, particularly rising global oil prices. Non-food inflation continued to rise, led by utility charges, while food inflation slowed down relative to the fourth quarter but was still higher than the average inflation posted in the same quarter a year ago. Similarly, core inflation remained on an uptrend indicating that price pressures have started to feed into other commodities other than the volatile food and energy components of the CPI.
Demand continued to expand, but soft spots remained. Christmas holiday demand and inflows of OFW remittances fueled strong consumer spending in the fourth quarter of 2004, accompanied by robust spending on imported goods and inflows from non-factor services. However, growth in fixed capital formation slowed from the third quarter as public construction spending fell and growth in durable equipment investments tapered off, leaving room only for inventory accumulation. Other available indicators of demand in the first quarter also continued to display mixed trends, suggesting some tentativeness in the overall strength of demand. In addition, employment conditions remained soft, with the jobless rate remaining at double-digits, while capacity utilization remained fairly below its maximum.
Ample market liquidity pulled down interest rates and boosted financial market activity. Ample liquidity in the banking system and improved market sentiment pulled down Treasury bill yields (and consequently bank lending rates) as Treasury bill auctions continued to attract large volume of bids from banks. Liquidity also found its way into local equities trading, which also benefited from upbeat market sentiment. Growth in commercial bank lending continued to improve during the quarter, but overall liquidity growth continued to be driven mainly by banks’ investments in government securities.
The peso staged a rebound in the first quarter of 2005. The local currency strengthened from sustained dollar inflows from OFW remittances and portfolio investments owing to a generally positive outlook for the domestic economy, which was tied to sustained economic growth and improved fiscal performance. The peso also benefited from the regional trend towards currency appreciation amid the prevailing weakness of the dollar.
Against this backdrop, monetary settings were left unchanged during the quarter. The Monetary Board kept the BSP’s policy interest rates steady during all of its meetings for the quarter, citing baseline forecasts indicating a deceleration toward the target by 2006 and the continued predominant role of supply-side factors in the inflation outlook. Equally important, assessment of various demand conditions continued to indicate resource slack in the economy, given by the moderate levels of capacity utilization alongside modest employment and lending growth. The observed expansion in aggregate demand has been driven largely by consumption and only partly by net exports and investment spending.
The path for inflation going forward continues to suggest a deceleration. Cost-side pressures, the driving factor for the inflation outlook, are expected to moderate over the policy horizon as the impact of supply shocks play themselves out. At the same time, overall output conditions continue to suggest slack in the economy. Recovery in money demand has taken place, but credit activity remains generally subdued.
The main policy concern for the near term is the impact of continued supply-side pressures on wage- and price-setting behavior. The prospect of sustained cost-side pressures are likely to fuel the risk of second-order effects in the form of nominal wage increases and other adjustments. This also implies a greater risk that the public will come to expect future inflation to continue to spiral away from the Government’s target.
The overall stance of monetary policy will be oriented towards responding to inflationary risks and delivering price stability over the policy horizon. The BSP will focus on assessing the evolving path for future inflation and demand conditions as well as the public’s inflation expectations and whether they continue to be well-anchored in the face of sustained commodity price increases. Policy action will be considered if there is strong evidence of demand-side effects arising from supply shocks, particularly in terms of adjustments in nominal wage rates in excess of losses in purchasing power.
At the same time, any prospective action toward monetary tightening will be taken primarily to guide inflation expectations. Significant monetary tightening does not appear justified at present given the prevailing inflation outlook, continuing presence of slack in the economy and indications of possible moderation in output growth. Although these conditions may change, any future monetary policy action should be geared more toward steering inflation expectations in the right direction rather than dampening demand-side impulses.