Peso rally seen to soften inflation

The peso’s five-day winning streak last week, capped by a major rally to a new high for the year on Friday, should help ease inflationary pressures, easing the burden of higher prices on consumers.

If the local currency’s rally is sustained, or at least if investors think it might, the economy could also benefit from a fresh surge of foreign cash entering the economy, the Bangko Sentral ng Pilipinas (BSP) said.

Last week, the peso closed at 43.65 against the dollar, its highest since November last year. This followed Standard & Poor’s surprise credit-rating upgrade for the Philippines’ sovereign debt.

“A currency appreciation is expected to contribute to lower inflation because of the impact of a stronger currency on prices of imported commodities,” BSP Governor Amando M. Tetangco Jr. told reporters.

Data released last week showed inflation or the average rise in consumer prices stood at 4.1 percent in April, accelerating from 3.9 percent the month before. Officials blamed the increase in prices on the higher cost of food as a result of tight supply due to poor harvests in typhoon-hit areas as well as more expensive imported fuel.

The BSP revised its projection for average inflation for 2014 to 4.3 percent from the previous 4.2 percent. This forecast is above the midpoint of the BSP’s target inflation range of 3 to 5 percent for this year.

Monetary officials were also wary of the possible effects of excess cash circulating in the economy on consumer prices later this year.  The BSP said drier weather later this year as a result of the so-called El Niño phenomenon might affect the agriculture sector as well. Power costs may also rise as a result as critical water levels at the dams put a strain on the ability of hydroelectric plants to generate electricity.

To ward off these risks, the BSP ordered banks at its policy meeting last Thursday to set aside more of their clients’ deposits as reserves—a move that aims to mop up about P60 billion from the economy.

Tetangco said the stronger peso would help higher prices, providing breathing room for monetary authorities.

“While the pass-through from the peso appreciation to inflation has declined over time, it would still be a counterbalance to the upside risks to the inflation outlook that we have noted in our last policy meeting, including that of higher food prices and higher transport costs,” he said.

Tetangco said the appreciating peso might also help in slowing down liquidity growth. A stronger peso makes dollar-denominated assets less valuable when converted into the local currency.