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BSP Raises Key Policy Rates for the First Time Since October 2000

04.07.2005

At its meeting today, the Monetary Board decided to increase the BSP’s policy interest rates by 25 basis points to 7.0 percent for the overnight borrowing or reverse repurchase (RRP) rate and 9.25 percent for the overnight lending or repurchase (RP) rate.

In its assessment of the outlook for inflation and output,  the Monetary Board noted that demand-driven inflationary pressures remain limited at present given fairly high unemployment, modest credit growth, and spare capacity in manufacturing. At the same time, the latest forecasts continue to show headline inflation declining towards the 4-5 percent target by 2006.

However,  the upside risks to the inflation outlook have increased given prevailing expectations for international oil prices, which are expected to remain high for the foreseeable future. In addition,  recent supply-side developments—particularly the increases in oil prices—may already be feeding into inflation expectations. The prospect of renewed cost-push pressures from rising oil prices and other supply-side factors, combined with falling real wages and rising inflation expectations implies a greater risk that the public will come to expect future inflation to continue to spiral away from the Government’s target. Such changes in inflation expectations have an impact on overall price- and wage-setting behavior in the economy. Under these circumstances,  the Monetary Board believes that a measured increase in policy interest rates can help prevent rising inflationary expectations from becoming widespread and entrenched and prevent ongoing supply shocks from generating second-round effects.

The Monetary Board likewise noted other risks to future prices. Exchange market pressure,  for example, remains a risk to inflation expectations, given the likelihood of declining interest rate differentials and possible adverse shifts in investor sentiment due to delays in needed tax measures. Recent increases in liquidity growth due to external inflows are also being monitored closely, because of the potential implications of the additional liquidity for exchange market stability and the inflation path.

The Monetary Board emphasized that the increase in the BSP’s policy interest rates is chiefly a preemptive move to prevent inflation expectations from spiraling away from the inflation target.  he policy action is intended as a response to rising inflation expectations, and underlines the BSP’s commitment to fighting inflation.

In the months ahead, the BSP will continue to assess the appropriate response to the risks to the inflation outlook, paying particular attention to adjustments in nominal wages and transport fares. The overall stance of monetary policy will be oriented towards responding to inflationary risks and delivering price stability over the policy horizon.

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