Hike, cut or hold?

PHILIPPINES - In Brief 08 Jan 2019 by Romeo Bernardo

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The inflation outlook has become much more benign following price declines over the last two months. We now expect the headline rate to fall back within target (2-4%) this quarter, averaging 2.9% for the full year. The significant adjustment in our inflation forecast since December (3.9%) also considers the impact of the rice tariffication bill. Rice prices have been falling in recent months, possibly influenced by expectations of a freer import regime. We tried to get into the BSP’s mind regarding its policy choices for this year and arrived at the conclusion that all else equal, it will likely hold rates steady. However, should the US Fed raise policy rates, we expect the BSP to keep step. At this time, given expectations of GDP growth remaining above 6%, we don’t expect it to cut rates; but we would not be surprised if it takes any lull in financial market volatility to reduce anew the reserve requirement on bank deposits and rely on its term deposit facility to tweak liquidity volumes. Why hike? Basically because faced with the policy trilemma[1], the BSP cannot afford to act independent of (mainly) the US Fed. Events last year revealed that if it tries to, it will lose credibility with markets, and dollar reserves[2], and risk unanchored expectations. The issue now is the timing of another Fed rate hike. Although the Fed signaled in December another 50bp increase this year, its Chair has lately said that it is not in a hurry to do so. Why not cut? The interest rate tool may be too blunt an instrument to use in a time of great external market uncertainty, especially without more clarity on what the US Fed will do or where the US-China trade war is headed. It is als...