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Monetary Board Keeps Policy Rates Steady in Q1 2010, Unwinds Liquidity-Enhancing Measures


The BSP announced today the publication of the 34th issue of the quarterly BSP Inflation Report covering the period January-March 2010. The full text of the Inflation Report has been released in electronic format (as a PDF file) on the BSP website (http://www.bsp.gov.ph/publications/regular_inflation.asp).  The BSP Inflation Report is published as part of the BSP’s efforts to improve the transparency of monetary policy under inflation targeting and convey to the public the thinking and analysis behind the Monetary Board’s decisions on monetary policy. 

The following are the highlights of the Q1 2010 BSP Inflation Report:

  • Inflation accelerates in Q1 2010. Headline inflation accelerated to 4.3 percent in Q1 2010 compared to 3.0 percent in Q4 2009 as energy prices drove up non-food inflation during the quarter.  Meanwhile, food inflation edged lower, with most major food groups registering declines in inflation rates as supply recovered from the impact of the recent typhoons. Inflation dynamics remained broadly unchanged, with second-round effects from supply-side pressures appearing to be limited. Core inflation increased during the quarter due mainly to higher power rates brought about by the El Niño weather condition, and is not reflective of broad-based demand-driven inflation. More importantly, inflation expectations continued to be well contained, with both BSP and private sector surveys showing expected inflation to be within the target ranges for 2010 and 2011.
  • Downside risks to domestic output growth ease.  Leading indicators of domestic demand show underlying resilience, with energy and vehicle sales as well as capacity utilization rates indicating a sustained pick-up in economic activity in the first quarter. These developments were reflected in the buoyant consumer and business confidence indices.
  • Signs of economic recovery on the global front are more evident. The progression of global recovery has surpassed expectations, with global manufacturing activity rebounding, global financial market conditions easing, and GDP growth turning positive in a number of major economies. Global recovery, however, remains fragile and uneven, given high unemployment, continued deleveraging by households, and weak public finances in major economies. In addition, it remains to be seen whether recovery can be sustained beyond the fiscal and monetary stimulus measures and the inventory restocking cycle.
  • Domestic financial markets remain stable while credit and liquidity conditions continue to improve.  Lower risk aversion among investors in emerging market economies reinforced the stability of the domestic financial markets. Compared to levels recorded during the crisis, bond debt spreads narrowed while exchange rate volatility eased. The domestic equities market also continued to post gains. Growth in domestic liquidity remained firm in Q1 2010, suggesting that ample funds were available to support the growth requirements of the economy.  Bank lending continued to grow, albeit at a slower pace, with the expansion of consumer loans, slower contraction of manufacturing and construction loans, and as credit standards generally remained unchanged based on the BSP’s survey of senior bank loan officers.
  • The BSP begins implementing its exit strategy from liquidity provision measures. The Monetary Board noted that as global credit markets continued to normalize, the risk of contagion from global financial stresses has been reduced markedly in domestic financial markets. With the smooth functioning of domestic financial markets, the Board decided to align the peso rediscounting rate with the overnight RRP rate effective 1 February 2010. In March, the Board decided to reduce the peso rediscounting budget from P60 billion to P40 billion. It also decided to restore the pre-crisis guidelines in the access to the rediscounting facility. These include restoring the loan value of all eligible rediscounting papers to 80 percent (from 90 percent) and reverting to the pre-crisis NPL ratio requirement for access to the facility of 2 percentage points (instead of 10 percentage points) above the industry average. The Board is of the view that the gradual disengagement from crisis intervention measures will encourage depository institutions to seek funding outside the BSP, thus promoting a more efficient distribution of funds in the financial system.
  • At the same time, the BSP keeps monetary policy settings unchanged in the first quarter. The Monetary Board's decision was based on its view that current monetary policy settings remained appropriate as inflation forecasts continued to be within the target ranges over the policy horizon. Inflationary pressures are also expected to remain manageable, with demand-side pressures on consumer prices expected to remain subdued over the near term given the modest improvement in domestic demand conditions and stable inflation expectations. At the same time, the Board noted that a broad range of indicators pointed to increasing momentum in domestic economic activity. Thus, while the recent pick-up in inflation has emanated largely from the supply side, upside risks to the inflation outlook need to be closely watched as these could lead to a build-up in inflationary pressures and influence inflation expectations, particularly given firmer signs of recovery in domestic economic activity.
  • Looking ahead, the latest inflation profile indicates that inflation will likely settle within the target ranges over the policy horizon. Given the prevailing assessment of the inflation environment, monetary settings are appropriate at the moment. At the same time, the withdrawal of crisis measures can proceed further given continued stable financial market conditions. Favorable credit and liquidity conditions also support the continued unwinding of the remaining crisis intervention measures under the rediscounting facility.

However, relative to the previous report, the latest baseline inflation profile shows a slightly elevated inflation path over the policy horizon. The factors that contributed to the upward shift in the inflation projections include the impact of the El Niño weather condition, possible increase in electricity rates, potential hike in transport fares, and upward revision in global economic growth forecasts.

Moreover, the risks around the central projection for inflation are skewed to the upside, and relate to the pace of global economic recovery, investor interest in commodity assets, the operating environment in the oil and agriculture sectors, power market developments, and the timing of exit strategies of major/advanced economies from accommodative fiscal and monetary policies.

  • The balance of risks to future inflation is, however, slightly tilted to the upside. Monetary authorities will watch closely inflation developments as pass-through effects of current supply shocks could lead to a potential build-up in inflationary pressures. Going forward, authorities resolve to stay vigilant against inflation pressures and to undertake timely and preemptive monetary policy actions to safeguard price stability. 

[At its meeting on 22 April 2010, the Monetary Board decided to keep the BSP’s key policy interest rates steady at 4 percent for the overnight borrowing or reverse repurchase (RRP) facility and 6 percent for the overnight lending or repurchase (RP) facility. The interest rates on term RRPs, RPs, and special deposit accounts (SDAs) were also left unchanged. With favorable credit and liquidity conditions, and as financial market conditions continued to stabilize, the Monetary Board also decided to reduce further the peso rediscounting budget from P40 billion to the pre-crisis level of P20 billion, effective 3 May 2010.]

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