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Intelligent Investing

Looser monetary policy–good or bad for stocks?

/ 05:06 AM March 18, 2019

Theoretically, high interest rates are bad for stocks while lower rates are good.

However, the relationship between interest rates and stocks is not straight forward as lower interest rates can also be bad when they are too low to keep prices stable or inflation in check.

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Two weeks ago, Budget Secretary Benjamin Diokno was appointed the new governor of the Bangko Sentral ng Pilipinas (BSP) to succeed Nestor Espenilla Jr., who died of cancer recently.

Although Diokno is highly qualified for the position, the market expects him to be more dovish and progrowth judging from his expansionary fiscal policy stance as the budget secretary. As such, he is expected to be less conservative compared to his predecessors as far as monetary policy is concerned.

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While being progrowth is good, it could also work negatively for the economy assuming the new central bank governor allows rates go down by more than what is necessary to encourage economic activity. This in turn could push up inflation, which only started to go down recently.

Last week, Diokno was quoted as saying that the BSP might cut the reserve requirement ratio (RRR), or the level of deposits that banks are required to keep with the BSP by one percentage point over the next four quarters for a total of four percentage points in 2019. This is faster than the two percentage points annual RRR cut being eyed by former governor Espenilla.

HSBC economist Noelan Arbis was quoted as saying he was expecting the BSP under Diokno to cut benchmark borrowing rate by 50 basis points for the full year. Under the watch of the late BSP Governor Espenilla, economists were not expecting any rate cuts for 2019.

Expectations of a looser monetary policy already hurt the peso. Last week, the peso depreciated by 0.425 against the US dollar to close at 52.665. Aside from expectations of lower rates, the peso weakened after Diokno was quoted saying that he was OK for the peso to trade within the 52 to 55 band.

However, the impact of having a more dovish central bank governor on the stock market is not yet clear. Even with the weaker peso, the PSEi ended the week flat at 7,798.28. Historically though, a weak peso has not been good for the stock market as foreign investors, which account for more than half of the Philippine Stock Exchange’s value turnover, sell their Philippine equity holdings when they expect the peso to be weak due to concerns of forex losses.

What seems to be clear is that our new BSP chief still needs to prove that he can be progrowth without sacrificing price stability. As such, investors are expected to closely monitor inflation and the outcome of the monetary board meetings in the next few months before judging whether or not Diokno can successfully balance his two objectives of growth and price stability.

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TAGS: Budget Secretary Benjamin Diokno, Business
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