The BSP announced today the publication of the 51st issue of the quarterly BSP Inflation Report covering the period April-June 2014. The full text is also being 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 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 2014 BSP Inflation Report:
- Headline inflation rises. Year-on-year inflation accelerated to 4.4 percent in Q2 2014 from the quarter- and year-ago rates of 4.1 percent and 2.7 percent, respectively, due to higher food and petroleum prices. Food inflation increased owing largely to some tightness in domestic supply conditions. Meanwhile, non-food inflation was unchanged as higher inflation for petroleum prices and education was offset by lower inflation for electricity, gas, and other fuels as well as rental fees. Meanwhile, core inflation was steady at 3.0 percent. The number of CPI components with inflation rates above the 5.0-percent threshold decreased but accounted for a bigger proportion of the CPI basket.
- Domestic demand remains firm. Real gross domestic product (GDP) growth decelerated to 5.7 percent in Q1 2014, reflecting largely the lingering effects of typhoon Yolanda (Haiyan), a smaller increase in capital formation, and a weaker expansion in manufacturing output. Nonetheless, strong private spending and exports recovery as well as solid gains in the services sector helped buoy output growth. Indicators of demand also continued to show positive readings. Vehicle and energy sales remained brisk, while the Purchasing Managers’ Index (PMI) continued to signal an expansion in domestic economic activity. The outlook of consumers and businesses for the following quarter also remained favorable, supporting the continued strength of aggregate demand in the coming months.
- The outlook for global growth has become uneven. Overall growth dynamics are seen to remain favorable in the advanced economies (AEs). Growth in the US remains intact despite the contraction observed in Q1 2014, which reflected temporary factors, notably the unusually cold winter season. The euro area is recovering gradually but continues to face the threat of deflation. Economic activity in Japan has also been brisk, but the recent increase in consumption taxes could dampen domestic demand. By contrast, recent indicators point to modest economic growth prospects in major emerging markets (EMs), as the momentum continues to soften in China and as the expansion in India remains subdued. Looking ahead, the global economy is likely to stay on a moderate expansion path, with the risks to the outlook tilted to the downside. Increased volatility in financial markets ahead of the expected normalization of policy interest rates by the US Fed, along with geopolitical risks in the Middle East and Ukraine, will likely weigh down on economic activity. Meanwhile, global inflation pressures are seen to remain broadly benign. The inflation environment in AEs continues to be muted given sizeable spare capacity. However, inflation has risen in some EMs owing to domestic supply factors.
- Local financial market conditions improve. Confidence in EM financial markets returned during the quarter after the US Fed indicated its intent to keep policy interest rates low even after asset purchases are fully wound down. Announcements of targeted measures to address the slowing growth in China also helped calm the market. Strong corporate earnings and the country’s credit rating upgrade by Standard & Poor’s, reflecting the country’s sound macroeconomic fundamentals, also boosted investor sentiment. Concerns over escalating unrest in Iraq as well as the increasing inflation readings during the quarter partly tempered market optimism, but financial markets nevertheless ended the quarter on a positive note as evident in the appreciation of the peso, narrowing of Philippine debt spreads, and the 11-month high rally of the Philippine stock market. Appetite for Philippine government securities was also strong, supported by ample market liquidity.
- The BSP maintains its policy settings but adjusts the reserve requirement (RR) ratio and the interest rate on the Special Deposit Account (SDA) facility. During its monetary policy meetings on 8 May and 19 June 2014, the Monetary Board (MB) decided to keep policy interest rates steady based on its assessment that the future inflation path was likely to stay within the announced target ranges for 2014 and 2015. However, following an earlier increase of one percentage point (ppt) effective on 11 April 2014, the BSP raised anew the RR ratio for banks (except rural banks) and non-banks with quasi-banking functions by one ppt effective on 30 May 2014 to help guard against financial stability risks that could arise from strong domestic liquidity growth and rapid credit expansion. The BSP also decided to increase the SDA rate by 25 basis points (bps) to 2.25 percent on 19 June 2014 to help mitigate potential price and financial stability risks emanating from ample liquidity.
- Prevailing inflation and output dynamics suggest that the economy can accommodate measured adjustments in interest rates. While latest forecasts continue to indicate that inflation will likely settle within the inflation target ranges over the policy horizon, the baseline inflation path has also shifted upward owing mainly to the higher inflation outturn in May as well as the inclusion of the potential impact of El Niño on food and utility prices. The risks to future inflation remain skewed to the upside, with potential price pressures emanating from a possible uptick in food prices due to drier weather conditions and pending petitions for adjustments in power rates. Meanwhile, the downside risk to the inflation outlook could stem from slower economic activity and its impact on commodity prices. At the same time, inflation expectations remain manageable although they have edged toward the upper end of the target range for 2015.
Moreover, domestic liquidity growth remains elevated but has eased in line with the path projected by the BSP. The recent adjustments in the RR ratio and SDA facility are seen to further mitigate the inflation risk from strong liquidity growth.
Notwithstanding the softer GDP growth in Q1 2014, domestic demand conditions remain solid. Aggregate demand is expected to continue to expand on the strength of robust consumer spending, increased public expenditure, and favorable market sentiment. Sustained growth in investments and bank lending also provide adequate support to domestic demand, suggesting that there is room for measured adjustments in monetary policy—if warranted—without unduly dampening growth. Meanwhile, prospects of second-round effects arising from supply-side pressures will require close monitoring. Going forward, the BSP will remain vigilant against a potential build-up in inflation expectations and financial imbalances. The BSP stands ready to undertake further policy actions as necessary to safeguard its price and financial stability objectives.
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