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Favorable Inflation Environment Continues in Q2 2013

08.08.2013

The BSP announced today the publication of the 47th issue of the quarterly BSP Inflation Report covering the period April – June 2013. The full text has been released in electronic format (as a PDF file) on the BSP website.  The BSP Inflation Report is published as part of the BSP’s efforts to improve the transparency of monetary policy under inflation targeting and to convey to the public the thinking and analysis behind the Monetary Board’s decisions on monetary policy. 

The following are the highlights of the Q2 2013 BSP Inflation Report:

  • Headline inflation eases due mainly to lower prices of non-food items. Headline inflation decreased to 2.6 percent in Q2 2013 from 3.2 percent in Q1 2013, bringing the year-to-date average inflation rate to 2.9 percent, slightly below the Government’s 2013 inflation target range of 4.0 percent ± 1.0 percentage point. This was due mainly to slower non-food inflation, owing to lower electricity rates and domestic petroleum prices. Inflation for most food items was also lower, reflecting adequate domestic supply of rice, corn, fish, milk, oils, and sugar. Similarly, the official measure of underlying inflation, along with the alternative measures of core inflation estimated by the BSP, was lower in Q2 2013 than in the previous quarter, indicating a relative absence of broad-based inflationary pressures. The official core inflation eased to 3.0 percent. The number of CPI components showing inflation rates above the 5.0 percent threshold likewise decreased, accounting for a smaller proportion of the CPI basket.
     
  • Domestic growth momentum continues to be robust. Real gross domestic product (GDP) grew by 7.8 percent in Q1 2013. On the expenditure side, strong household spending and capital formation supported growth, offsetting the negative contribution from exports owing to continued external headwinds. Likewise, all three major production sectors recorded solid gains. Recent indicators of activity for Q2 2013 also pointed to steady growth momentum, supported by upbeat consumer and business sentiment. Vehicle and energy sales have been strong, while sustained credit growth and ample liquidity are seen to provide a further boost to domestic demand going forward. At the same time, survey-based indicators continue to signal a steady expansion of economic activity, particularly in manufacturing.
     
  • Prospects for global growth remain modest. The economic recovery in the US has been proceeding at a stable pace, while the economic downturn in the euro area has continued to persist. Economic activity in Japan has gained further traction, supported by accommodative monetary policy measures. However, recent indicators suggest weaker domestic demand in major emerging economies. Consequently, the IMF reduced its global growth projections in July, reflecting new downside risks to the growth outlook centering on the possibility of slower growth in emerging markets and tighter financial market conditions, especially if the early tapering of monetary stimulus in the US leads to a sharp reversal of capital flows. Meanwhile, inflation dynamics are seen to remain manageable as favorable food and fuel supply conditions in the global front are seen to limit upward pressures on commodity prices. The inflation environment in advanced economies continues to be benign given the presence of spare capacity, while the prospect of softer demand in emerging economies presents a downside risk to the inflation outlook.
     
  • Financial market volatility increases. Market sentiment had been broadly bullish in the first semester, bolstered by optimism over the country’s better-than-expected Q1 2013 growth and the Philippines’ credit rating upgrade to investment grade by Standard and Poor’s and Fitch Ratings. However, global financial markets saw significant volatility following indications from the US Federal Reserve that it would scale down its asset purchase program in late 2013 amid signs of improving economic prospects in the US. Uncertainty over the scale and timing of the anticipated exit from quantitative easing in the US resulted in capital outflows from emerging economies. In the Philippines, the stock market index retreated, the peso depreciated against the US dollar, and spreads on Philippine debt widened, indicating renewed risk aversion. Yields on government securities also increased on expectations of an end to the current low interest rate environment. Nonetheless, demand for T-bills remained robust, reflecting ample liquidity in the market and investors’ search for higher-yielding assets, following further reductions in the interest rate on the BSP’s Special Deposit Account (SDA) facility. Money supply has also continued to expand, buoyed by brisk credit activity.
      
  • The BSP maintains policy rates but reduces SDA rates by 50 basis points (bps). During its monetary policy meetings on 25 April and 13 June, the Monetary Board (MB) decided to keep its policy interest rates steady on its assessment of a manageable inflation outlook. Meanwhile, the MB reduced the interest rate on the SDA facility by 50 bps during its policy meeting on 25 April, noting that the benign inflation environment and robust domestic growth outlook provided scope for further enhancing the effectiveness of its monetary policy operations in promoting price and financial stability. In addition, the MB approved the revised operational guidelines on the access of trust departments/entities (acting as trustees) to the BSP’s SDA facility on 9 May 2013.
      
  • Prevailing inflation and output dynamics support the maintenance of current monetary policy settings. Baseline forecasts indicate that inflation is likely to remain in line with the 4.0 percent ± 1 percentage point target range for 2013-2014 and 3.0 percent ± 1 percentage point target range for 2015, supported by well-anchored inflation expectations. The risks to the inflation outlook are also considered to remain evenly balanced. Uncertainty over the strength of the global economy is expected to moderate pressures on international commodity prices. However, upside risks to the inflation outlook could emanate from additional petitions for adjustments in electricity rates in Mindanao and from the impact of sustained growth in liquidity. Meanwhile, indications of firm domestic demand suggest that the domestic economy continues to receive ample monetary stimulus.

Moreover, recent financial market volatility suggests caution in monetary policy formulation. While financial markets have somewhat calmed down after initial uncertainty over the timing of the US Fed’s exit from its quantitative easing measures, emerging markets such as the Philippines continue to face the risk of sharp capital flow reversals. The recent fine-tuning measures of the BSP could help moderate the impact of market volatility by providing adequate liquidity in the system to support the country’s funding requirements. Going forward, the BSP will continue to monitor evolving price and output developments to ensure that the monetary policy stance remains consistent with maintaining price and financial stability while supporting sustainable economic growth. The BSP also stands ready to employ appropriate measures as necessary to address pre-emptively any potential build-up in financial imbalances.

[On 25 July 2013, the MB decided to maintain the BSP’s key policy rates at 3.50 percent for the overnight borrowing or RRP facility and 5.50 percent for the overnight lending or repurchase (RP) facility. The interest rates on term RRPs, RPs, and SDAs were also left unchanged accordingly. Reserve requirement ratios were kept steady as well.]

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