The BSP announced today the publication of the eighteenth issue of the quarterly BSP Inflation Report covering the period January-March 2006. The full text of the Inflation Report was released today in electronic format (as a PDF file) and may be downloaded from the BSP website (http://www.bsp.gov.ph/publications/regular_inflation.asp). A print version will be made available by mid-May 2006. 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 First Quarter of 2006:
- In line with expectations, inflation rose in the first quarter of the year, reflecting the impact of the two-percentage point increase in the Value Added Tax (VAT) rate. However, first-quarter average inflation was lower relative to the same quarter in 2005 as the upward pressures on inflation were cushioned by the strengthening of the peso, stabilizing liquidity growth and the rollback in prices of selected oil products in March. Meanwhile, demand and credit conditions remained soft, implying limited demand-based price pressures. For example, latest available data for the fourth quarter of 2005 suggest that consumption growth—the key driver of aggregate demand—slowed down due to the dampening effects of higher consumer prices.
- Liquidity growth has stabilized but remained ample. In tandem with improving market sentiment, this lowered market interest rates and strengthened the peso during the first quarter. Reduced government borrowing helped temper the growth in domestic liquidity, which nonetheless remained ample due to foreign exchange inflows from Overseas Filipino Worker (OFW) remittances and portfolio investments. Positive market sentiment owing to improvements in the fiscal sector has driven down bond yields and contributed to the strengthening of the peso against the US dollar.
- Global economic activity remained fairly robust, led by the US and other major economies, with modest inflation pressures and muted core inflation. Emerging Asian economies, meanwhile, continued to benefit from stronger global information technology demand but remained at risk from high oil prices. The solid performance of the services sector and renewed strength in manufacturing underpinned growth in most economies. Although short-term price movements appeared to be dominated by global oil prices, inflationary pressures continued to be modest, with generally muted core inflation in most economies.
- Monetary authorities in major central banks opted to tighten their monetary policies. The US Federal Open Market Committee (FOMC) raised its target for the federal funds rate by 25 basis points in March, noting that further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. Similarly, the European Central Bank raised its policy interest rate by 25 basis points in March to help anchor medium to long-term inflation expectations.
- For its part, the Monetary Board kept the BSP’s policy rates unchanged during the first quarter. The Monetary Board’s decision to keep policy rates steady was based on the assessment that price and demand conditions continued to point to generally manageable inflation in the near term. Despite the impact of the increase in the VAT rate, inflation forecasts continue to point to a deceleration in the second half of 2006.
- Looking ahead, a number of factors provide continued policy space to keep monetary settings steady in the near term. Soft demand conditions, moderating cost-push pressures, the relative absence of evidence of second-round effects from cost-push pressures (especially in the form of wage increases), and stable inflation expectations all suggest a manageable inflation path in the near term.
- Nevertheless, there continue to be risks to the outlook for inflation, particularly for 2007. Policymakers thus remain alert to the various sources of renewed inflation pressures. Oil prices constitute the dominant risk to the outlook for prices in the face of limited global spare capacity, making energy prices vulnerable to any perceived uncertainty in the supply chain. Pending adjustments in domestic power transmission charges imply eventual increases in energy costs at the retail level. Other potential sources of price pressures on the supply side include the La Niña weather phenomenon, which could disrupt crop production, and the threat of the Avian Flu virus.
- Monetary authorities remain strongly committed to achieving the inflation target for 2007 and addressing the risks to future inflation. In the months ahead, the main policy priority continues to be that of managing the risk of potential second-round effects on wage and price setting. Assessing the likely extent of wage increases in the private sector should be a key task for monetary assessment in this regard. The BSP remains prepared to undertake future tightening if necessary, depending on how quickly the inflation risks escalate. The prospect of additional cost push increases, particularly in energy prices, also has a bearing on inflation expectations, and may necessitate timely policy action. Authorities will also remain watchful of any potential volatility in the foreign exchange market given prevailing trends in interest differentials.
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