Should we be concerned with rising inflation?

One of the major risks highlighted by economists for 2021 is rising inflation.

Domestically, inflation rate increased from below 3 percent during the 10 months to October of 2020 to 3.3 percent in November and 3.5 percent in December, driven by higher food and transport costs.

Globally, commodity prices are rising due to supply issues and as economies recover from the COVID-19 pandemic. Prices of crude oil and coal, industrial commodities such as nickel and copper, and even food commodities such as palm oil and wheat are now close to—if not higher—than prepandemic levels.

Inflation is expected to remain on an uptrend in 2021 as the global economic recovery continues, driven by the rollout of vaccines and governments’ aggressive stimulus measures.

As inflation picks up, there is a risk that interest rates will also go up, which is not good for financial markets. In fact, the US 10-year bond rate is now at 1.09 percent after staying below 1 percent since the middle of March last year.

There is also a risk that central banks will be forced to raise interest rates and abandon their expansionary monetary policies to control inflation, which is not good for economic growth as borrowing costs become more expensive.

Although inflation is expected to remain elevated this year, I don’t think we are at risk of seeing a significant jump in interest rates.

Demand remains very weak as evidenced by the high unemployment rate and the low-capacity utilization of businesses. Note that as of October 2020, the number of employed Filipinos was only 39.8 million, way below its peak of 42.7 million in January. Meanwhile, the average capacity utilization in the industry and construction sectors was only 67.9 percent as of the fourth quarter of 2020, way below the 75.3-percent average during the past four years. As a result, even if the economy continues to recover, there is no pressure for businesses to pay higher wages and to expand their production capacity to meet growing demand.

The price of rice also remains stable even in November and December when food inflation picked up. Recall that the sharp increase in rice prices was one of the main reasons for the significant rise in inflation to 6.7 percent in September 2018 since rice accounts for a large share of Filipinos’ consumption basket.

Rice prices should remain stable this year. Even with the recent typhoons, the country was able to produce 19.4 million MT of palay in 2020, up 2 percent year-on-year. For 2021, the Department of Agriculture (DA) is targeting to produce 20.5 million MT of palay, higher by 6 percent compared to 2020, thanks to various government assistance measures. Because of the this, the DA is projected to import only 1.69 million MT of rice this year, or 15.5-percent less compared to a year ago.

Inflation expectations also remain steady. In the BSP’s latest consumer confidence and business confidence surveys, both households and businesses said they expected inflation to increase slightly in the first quarter of 2021, but still be within the 2-3 percent level or well within the BSP’s comfort zone.

Finally, even though longer-term interest rates in the United States are going up, the Fed has the option of adjusting its bond buyback or Quantitative Easing (QE) program given the negative implications of much higher interest rates. During its December Federal Open Market Committee meeting, the Fed said it remained committed to buy at least $120 billion worth of bonds each month until maximum employment is reached and inflation rate hits 2 percent. At its recent meetings, Fed officials have also been discussing the advantages of lengthening the duration of the bonds it is purchasing as it has been buying mostly shorter-duration bonds since the start of the pandemic.

Although the inflation rate is something that we should closely monitor this year, I am not too concerned that it will significantly affect the domestic economy and financial markets the way it did in 2018. It may cause some volatility in the short term, but I don’t think it will derail the recovery of the stock market or cause the PSEi index to fall sharply. INQ