Breaking a potentially vicious feedback loop

PHILIPPINES - In Brief 28 Jun 2018 by Romeo Bernardo

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On Monday, the benchmark Philippine stock index fell below 7,000 into what stock analysts call bear territory. This transpired after a fortnight of turmoil in emerging markets precipitated by an escalation of the face off between the US and China on the trade front. Alongside market read of a more hawkish US Fed, capital fled emerging markets resulting in prices of equity and currencies tumbling. Amidst the turbulence, the Philippines drew unwanted attention for having the worst performing currency and stock market. Many reasons were advanced for this including rising inflation, rising external and public deficits, as well as greater policy uncertainty with respect to fiscal authorities’ proposed changes in corporate taxation and monetary authorities’ supposed slowness in responding to US Fed rate hikes.While we were not entirely surprised by the BSP’s decision to raise its policy rate last week, we found its stated reason, based on anchoring inflation expectations and managing risk of second-round effects, unsatisfying. After all, it had just pared its inflation forecasts which showed the headline rate falling back within target over the policy horizon, which is also what analysts expect. Hence, we concluded that the peso’s performance may have been the proximate reason for the rate hike.In fact, more than any one thing, we think that there has been a shift in the attitude of monetary authorities given recent market turmoil. While they remain convinced of the economy’s fundamental strengths, manageability of inflation and desirability of a weaker peso, there is now greater sensitivity to positive feedback loops in financial markets that could potentially turn vicious ...