We are pleased to announce today the publication of the fourteenth issue of the quarterly BSP Inflation Report covering the period April-June 2005. The full text of the Inflation Report has been released today in electronic format (as a PDF file) and may be downloaded from the BSP website). A print version will be made available by end-August 2005. The BSP Inflation Report is being published as part of the BSP’s transparency mechanism under inflation targeting and to convey to the public the overall thinking and analysis behind the BSP’s decisions on monetary policy.
The following are the highlights of the BSP Inflation Report for the Second Quarter of 2005:
Inflation eased in the second quarter of 2005. This was influenced largely by the slowdown in food inflation amid the continued rise in prices of energy-related items and other non-food commodities. Cost-push factors, particularly the volatile oil prices and the effects of El Niño weather disturbance, continued to drive price pressures. Meanwhile, core inflation also decelerated during the quarter.
There is a risk that public’s inflation expectations may rise as actual inflation remains relatively high. A prolonged period of price increases creates the risk that the public will come to believe that inflation will continue to stay high for the foreseeable future and continue to exceed the Government’s inflation target.
The growth in economic activity moderated in the second quarter. The domestic economy continued to grow during the first quarter of 2005 but at a slower pace due to the moderation in consumption and export growth as well as lower farm output. Private consumption—the main driver of growth—decelerated as the increase in the prices of goods and services dampened consumer demand while sluggish foreign demand led to lower export growth. Likewise, other demand indicators suggest the continued presence of slack in the economy as the unemployment rate remained sizable. In addition, results of expectations surveys were less optimistic.
Domestic interest rates sustained its easing trend during the quarter. The benchmark 91-day T-bill rate and bank lending rates declined in the second quarter due to ample liquidity in the system and relatively upbeat market sentiment. These factors have also fueled the appetite for both equities and stocks. Meanwhile, lending by commercial banks (KBs) continued to increase at a modest rate while banks’ placements under the BSP’s reverse repurchase (RRP) window continued to rise. In general, overall liquidity growth was driven mainly by bank’s investments in government securities.
The peso appreciated against the US dollar. The peso continued to strengthen owing to the surge in dollar inflows from overseas Filipino workers (OFWs) in time for the school enrollment season and inflows of foreign funds buoyed by steady progress in the fiscal sector. However, the peso began to depreciate in the latter part of the quarter, in reaction to political developments.
Global economic expansion led by the US economy proceeds, albeit at a moderate pace relative to a year ago. Consumer spending and exports growth moderated in most economies while labor market conditions remained generally favorable. Manufacturing activity, meanwhile, eased due in part to higher world oil prices. The inflation outlook in major economies continues to be well-anchored despite higher inflation outturns. Forward-looking global economic indicators appear consistent with a moderate but solid growth performance in the year ahead. There are, however, downside risks to the outlook such as the widening global imbalances and sustained volatility in oil prices.
As a pre-emptive move against the threat that rising inflation could feed into higher inflation expectations, the Monetary Board decided to raise the BSP’s policy rates by 25 basis points on 7 April 2005. The Monetary Board noted that that the upside risks to the inflation outlook have increased given that expectations for international oil prices indicate that these are likely to remain high for the foreseeable future. In addition, other supply-side developments could also feed into inflation expectations. Such changes in inflation expectations can have an impact on overall price- and wage-setting behavior in the economy. The policy rate increase was intended chiefly to guide inflation expectations and underscores the BSP’s commitment to fight inflation.
The BSP maintains its assessment of above target inflation in 2005 and possibly, in 2006. Expectations of continued rise in oil prices remain the central influence on the path of inflation, since the continuing presence of slack in the economy is likely to prevent an upsurge of demand-related pressures in the near term. In particular, volatility in global oil prices may remain a key factor driving the inflation process. Moreover, the impending implementation of the Value Added Tax (VAT) Reform Law is also expected to raise inflation in the short-run.
Underlying conditions in the inflation environment continued to be driven mainly by rising oil prices and related pressures. Demand-side pressures on prices remain modest amid evidence of moderating consumption growth, sluggish private credit activity, and general indications of spare capacity in the economy.
The continued evidence of a moderating pace of demand expansion suggests that prospective monetary decisions should favor supporting conditions for growth in aggregate demand rather than dampening demand impulses. Direct non-monetary action against supply-side risks should remain a key policy strategy, and all potential avenues for non-monetary intervention in the supply and delivery of affected commodities should continue to be explored and pursued accordingly.
On the other hand, monetary authorities should also continue to monitor indicators of inflation expectations to ensure that monetary policy will be able to act pre-emptively in case of an adverse shift in public inflation expectations.
Monetary authorities could also continue to strengthen transparency and communication of policies and prospects of inflation in order to manage inflation expectations.
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