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BSP Maintains Key Policy Rates

07.29.2004

At its meeting today, the Monetary Board decided to keep the BSP’s key policy interest rates unchanged at 6.75 percent for the overnight borrowing or reverse repurchase (RRP) rate and 9.0 percent for the overnight lending or repurchase (RP) rate.

The decision to keep rates unchanged was based on the Monetary Board’s assessment that the prevailing outlook for future inflation and output growth continues to support the argument for maintaining present monetary settings. In particular, the BSP’s latest outlook for inflation shows higher forecasts for inflation in 2004-2005 but the projected uptrend will be driven mainly by pressures from temporary supply-side factors, which cannot be addressed directly by monetary policy. Monetary tightening restrains inflation pressures primarily by curbing aggregate demand, and the direct impact on consumer goods of supply-side factors, such as movements in world oil prices, is on production costs rather than on demand.

The Monetary Board is of the view, therefore, that the expected uptrend in inflation is temporary and would not require monetary action. On the other hand, the application of non-monetary government measures, such as those enabling timely importation, may help ease the ongoing supply pressures on certain consumption goods. At the same time, experience with past episodes of supply-side inflation pressures also shows that headline inflation tends to quickly revert to its long-term trend after a brief upsurge. For example, past transport fare increases stemming from oil price increases have led mainly to short-lived surges in headline inflation. Equally important, the overall conditions for aggregate demand, credit activity and investments suggest against monetary tightening which could have a contractionary impact on the economy.

Nevertheless, BSP forecasts indicate that annual inflation is likely to track the upper end of the 4-5 percent target for 2004 and briefly exceed the inflation target in 2005, before decelerating to between 4-5 percent in 2006.

In the event that the 2005 target is exceeded as confirmed by the release of official NSO data in January 2006, the BSP will issue an open letter to the public outlining the reasons behind the deviation of actual inflation from the target, what monetary authorities did in response to the deviation, and why they chose to respond in such a fashion. The framework of inflation targeting allows sufficient flexibility for monetary authorities to deal with unforeseen developments or shocks to prices. Equally important, it also recognizes the limits of the effectiveness of monetary policy by providing for a clear definition of the acceptable circumstances under which an inflation-targeting central bank may fail to achieve its inflation target. These circumstances include: (a) movements in prices of agricultural products, (b) natural calamities; (c) movements in international oil prices, and (d) changes in government administrative measures.

The Monetary Board wishes to emphasize that the BSP remains firmly committed to delivering stable prices, and will therefore continue to monitor the development of second-round effects from supply-side pressures so as to assess the need for policy rate action in the future. In addition, given the dominant role of supply-side developments in the inflation outlook, the BSP has made representations with relevant agencies of government on the importance of pursuing policy measures directly aimed at addressing price pressures emanating from the supply-side.

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