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Analysis and Recommendation
The Bangko Sentral ng Pilipinas (BSP) took the decisive step of raising its benchmark interest rate by 25 basis points (0.25%) last week, setting it at 6.5%, in response to the pressing issue of surging inflation. This action was taken ahead of the regular Monetary Board meeting, underscoring the urgency of addressing the escalating price levels in the country.
The alarm was sounded when September’s inflation rate spiked to 6.1%, a significant leap from the preceding month’s 5.3%, prompting the BSP to act proactively. Additionally, interest rates for overnight deposit and lending facilities were also raised, reaching 6.0% and 7.0%, respectively, from 5.75% and 6.75%.
Before this off-cycle rate hike, the BSP had maintained its policy rate at 6.25% since March 2023, marking a pause in rate adjustments.
Our View: The interest rate hike is a move that was widely expected. It is a proactive measure taken by the Monetary Board to manage inflation expectation, but this policy also has several implications.
Firstly, the rate hike is likely to provide essential support to the Philippine peso relative to the U.S. dollar, which, in turn, offers a degree of protection to businesses holding substantial dollar-denominated debt, such as San Miguel Corporation (SMC). Higher interest rates can limit inflation by discouraging borrowing and spending, although their full impact on inflation and the economy may take between 9 and 12 months to materialize.
The rate hike can also lead to a reduction in investment activity, lower productivity, and slower GDP growth, as it negatively impacts bank lending. The banking sector, which has been benefitting from higher net interest margins, may start to feel the pinch of higher rates as obtaining credit becomes more challenging and costly. Bank lending growth has steadily been declining since it peaked at 13.9% last October 2022 and is now at its slowest rate in nearly two years at 7.2%.
In addition, the affectivity of monetary policy to address inflation may be limited as domestic inflation is primarily driven by supply-side factors. Consequently, while the rate hike aims to curb inflation, it may simultaneously result in economic growth deceleration and present challenges for consumers due to pricier loans, influencing the overall economic landscape.
As for the Peso, the BSP’s latest move takes the interest rate differential with the Federal Reserve back to 100 bps, which is within the 100-150 bps range that is typically the norm.
This should take some pressure off the peso which has lately been repeatedly testing the P57.00 level that the BSP vowed to defend. Multiple factors, such as imports, foreign fund outflows and remittance inflows, could affect the demand and supply dynamics in the dollar market, but we see these factors mostly cancelling each other out, resulting in a more stable peso.
This should be a positive for net importing companies, particularly food manufacturers which have been showing signs of margin compression in recent quarters.
Overall, while we do not expect the PHP/USD exchange rate to return to P55.00 levels anytime soon, at least it is now less likely for it to breach P57.00. This would also prevent the BSP from burning through its dollar reserves in its efforts to defend the peso.
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