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BSP Maintains Key Policy Rates.

06.02.2005

At its meeting today, the Monetary Board decided to keep the BSP’s key policy interest rates unchanged at 7.0 percent for the overnight borrowing or reverse repurchase (RRP) rate and 9.25 percent for the overnight lending or repurchase (RP) rate.  

During its deliberations on the monetary policy stance, the Monetary Board noted that the outlook for inflation and domestic demand suggests that there is flexibility for monetary authorities to maintain current policy settings based on the following considerations: 

The prevailing and emerging risks to inflation are associated mainly with supply-side or cost-push factors (such as the VAT reform, oil prices and imminent adjustments in transport fares).  These factors are expected to push the future inflation path upward in the short term but are unlikely to have a lasting impact on prices in the absence of sustained shocks. 

Demand side pressures continue to be muted due to cyclical and structural conditions, including high unemployment and weak credit demand.   Authorities also noted that various measures of core inflation show indications of an easing.

There is a need to preserve the conditions for continued expansion in aggregate demand given emerging indications of the contractionary impact of the oil shock and the expected impact of fiscal adjustment via VAT reform on growth in the short run.   

At the same time, continued supply-side pressures may influence inflation expectations.  While monetary policy action is not the appropriate response to address the effects of ongoing supply shocks on inflation, it will try to mitigate inflation from feeding into higher wages and prices of other goods and services. The monetary authority therefore, stands ready to take action in order to guide inflation expectations and signal the BSP’s commitment to fight inflation. 

The risk of exchange market pressures due to declining interest rate differentials has been largely contained by continued strong foreign exchange inflows from OFWs and portfolio investments.

Given the predominance of supply shocks in the current inflation uptrend, policy responses via interest rates have been geared mainly toward steering inflation expectations rather than curbing demand.   

Members of the Monetary Board believe that the recent policy rate increase should be given time to fully work its way into the economy and exert its impact on inflation expectations. Significant monetary tightening does not appear to be justified by the extent of ongoing demand-side pressures, given sluggish employment conditions, moderate capacity utilization, and generally modest credit demand. 

On the whole, the Monetary Board remains strongly committed to fighting inflation and continues to pay close attention to the risks to the inflation outlook.  Authorities emphasize that current monetary policy strategy under the inflation targeting framework seeks to respond primarily to future inflation,  guided by an appreciation of the nature of ongoing inflation shocks.  Decisions on policy interest rates are therefore based on the outlook for inflation, with emphasis on the likelihood of emerging demand-side pressures and adverse shifts in inflation expectations. 

In the months ahead, the Monetary Board will continue to discuss the appropriate policy response to help contain the greater risk of rising inflation, emerging second-round effects from cost-push sources, and public inflation expectations.

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