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Monetary Board Keeps Policy Rates Steady in Q3 2010


The BSP announced today the publication of the 36th issue of the quarterly BSP Inflation Report covering the period July-September 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 Q3 2010 BSP Inflation Report:

  • Inflation decelerates further in Q3 2010. Headline inflation dropped to 3.8 percent in Q3 2010 compared to 4.2 percent in Q2 2010 as a result of lower non-food inflation, traced mainly to the rollbacks in the prices of petroleum products prompted by lower international crude oil prices. Meanwhile, core inflation increased slightly to 4.0 percent from 3.9 percent in the previous quarter due largely to the higher cost of power at the Wholesale Electricity Spot Market (WESM). 
  • Available indicators point to a solid pick-up in domestic demand. Real GDP grew strongly in the first half of 2010, buoyed by the expansion in private demand and capital formation, as well as the continued recovery in exports. Economic activity was supported in part by election-related spending and rebuilding efforts following the typhoons in the second half of 2009.  Capacity utilization in the manufacturing sector remained high while merchandise trade activity continued to grow robustly. Business confidence and consumer sentiment continued to improve while labor demand showed signs of picking up as the unemployment rate dropped significantly in July 2010.
  • Global economic activity strengthens in the first half of 2010 but the pace of recovery is expected to moderate in the near term. Output growth in most advanced economies continued to be held down by weak consumer confidence, tepid employment conditions, and impaired household balance sheets. Meanwhile, recovery in emerging economies proceeded at a stronger pace on the back of resilient domestic demand and increased investment spending. The rebound in global trade also benefited the manufacturing sector of advanced Asia, helping propel growth in the rest of the region. Risks to the growth forecasts are mainly on the downside, although the possibility of a sharp global downturn due to the sluggish recovery in advanced economies appears slim. Meanwhile, inflation is expected to be generally subdued as substantial slack in the global economy remains and employment conditions continue to be soft. 
  • Domestic financial market conditions improve further on the back of positive economic developments on the local front and easing concerns about the sovereign debt problem in some parts of Europe. Renewed appetite for emerging market assets encouraged by international yield differentials favoring emerging markets in the region likewise underpinned steady capital inflows to the country.   These were translated into bullish trading in the local bourse, generally narrower Philippine bond debt spreads, and the appreciation of the peso. Meanwhile, the robust expansion in bank lending continues to suggest ample funds for the growth requirements of the economy despite the slower growth of domestic liquidity.
  • The favorable inflation dynamics over the policy horizon have provided the BSP with the flexibility to keep policy interest rates steady during the quarter. The favorable outlook for inflation has allowed the BSP to keep policy rates steady since July 2009. The Monetary Board (MB) noted that inflation projections continued to indicate a manageable inflation environment, with inflation averaging within the target ranges for 2010-2012. The forecasts were also supported by well-contained inflation expectations while the various measures of core inflation point to a broadly stable trend for consumer prices.
  • Meanwhile, the BSP has announced the shift to a fixed medium-term inflation target from a variable annual inflation target on 15 July 2010.  The adoption of a fixed medium-term target is expected to help promote a long-term view on inflation, increase the predictability of monetary policy and better anchor inflation expectations. For 2012-2014, the inflation target range was set at 4.0 ± 1.0 percent. 
  • The baseline inflation scenario, going forward, remains favorable, consistently tracking a within-target inflation path. Compared with the projections in the previous report, the latest forecasts follow a slightly lower trajectory, due mainly to lower actual inflation outturns and the continued strength of the peso during the quarter. Well-contained inflation expectations over the policy horizon also support the within-target inflation outlook. Recent surveys of private economists showed that inflation expectations have been steadily declining, reflecting in part the general downtrend of headline inflation as well as prospects of slower global economic growth in the near term and its potential impact on international commodity prices.
  • The economy, therefore, continues to be at a point where the goal of safeguarding inflation is compatible with that of helping support economic activity, as inflation remains low even as demand has strengthened. While output growth appears to be gaining momentum, inflation pressures have remained subdued due to a number of reasons. Capital formation will help to increase the economy’s productive capacity, therefore tempering the build-up of demand-induced price pressures. At the same time, favorable labor market conditions are likely to moderate pressures for wage increases. World economic conditions also point to a tepid global recovery, keeping a lid on imported price pressures.
  • Nonetheless, the BSP will remain attentive to inflationary pressures going forward to ensure that monetary policy settings continue to be appropriate. Potential sources of upward pressures on future inflation include a possible rebound in oil prices given the continuing strong demand in emerging economies, the impact of adverse weather conditions on agriculture, petitions for electricity rate adjustments, and a stronger-than-expected domestic economic recovery that could induce demand-side price pressures. Meanwhile, the inflation path may be dampened by a slow recovery scenario for global growth and a sustained strengthening of the peso which could temper the impact of imported inflation.

[On 7 October 2010, the Monetary Board decided to maintain the RRP and RP rates at 4.0 and 6.0 percent, respectively. The Monetary Board also maintained the current interest rates on term RRPs, RPs and SDAs. The current reserve requirement ratio was also kept unchanged.]

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