US Fed hike turns up pressure on BSP

The latest interest rate hike implemented by the United States Federal Reserve heightened the need for the Bangko Sentral ng Pilipinas (BSP) to tighten its own policy stance more aggressively in order to maintain a “healthy” difference in rates along with the two countries’ different credit standing, according to market watchers.

The US Fed on June 15 again raised the federal funds rate by 75 basis points (bps). This was the biggest US Fed hike since 1994 and brought to 150 bps the cumulative increases since March when the American central bank started tightening monetary policy.

Since the BSP’s overnight borrowing rate was brought to a record low of 2 percent in November 2020 as part of efforts to help cushion the impact of the COVID-19 pandemic, the Philippine central bank has raised its policy rate by only 25 bps so far, to 2.25 percent in May.

Michael Ricafort, chief economist at the Rizal Commercial Banking Corp., said in a commentary the US Fed funds rate could reach 3.4 percent—or about double the rates today—by the end of 2022 based on the latest estimates by US Fed officials.

“Higher Fed rates could lead to further upward adjustments in the local [BSP] policy rate from the current 2.25 percent, which is already too close or tight vis-a-vis the upper end of the Fed Funds Rate now already at 1.75 percent, or a difference of 50 basis points,” Ricafort said.

“There is a chance of a local policy rate hike of 50 bps on the next [BSP] rate-setting meeting on June 23, and more local policy rate hikes for the rest of the year,” he added. “This is “partly to maintain a comfortable interest rate differential with the US, to account for the comfortable spreads/interest rate differentials/risk premium—a dilemma faced by many other countries/central banks around the world.”

Ricafort said that if the US Fed funds rate does reach 3.4 percent by year-end, the BSP’s policy rate could potentially increase further to at least 3 percent to 4 percent.

Emilio Neri Jr., lead economist at the Bank of the Philippine Islands, also pointed out that with the latest US Fed hike, data since 1993 show that the difference between US Fed and BSP policy rates are now at their narrowest ever—50 bps to 75 bps or 0.5 percent to 0.75 percent.

“If the [US Fed] hikes by 75 bps again in July and the [BSP] only hikes by 25 bps on June 23, the BSP rate would be lower than the US Fed rate for the first time,” Neri said.

“Avoiding a lockstep series of adjustments [with the US Fed] will most likely exert more pressure on the Philippine peso, which is already being strained by the demand recovery and elevated global commodity prices,” he added.

For BDO Unibank chief market strategist Jonathan Ravelas, the upsized, 75-bp interest rate hike of the US Fed would warrant a 50-bp increase by BSP’s Monetary Board next week.

If the BSP won’t hike faster, the peso could weaken to 54 against the US dollar, Ravelas said, adding that the expected move would be “a calibrated response.”

For Nicholas Antonio Mapa, senior Philippine economist at Dutch financial giant ING, the BSP’s ongoing rate hike cycle was behind the curve of normalization of central banks worldwide due to elevated global consumer prices, although he noted that “there’s much debate about where the curve really is.”

“I think the fact that inflation expectations have unraveled is the main determinant for saying that. People can talk about inflation, real rates, etc. But the real job of the BSP is to anchor inflation expectations. And they’re way behind on that because of their perceived dovish mess,” Mapa said.

“Rate hikes this year are totally warranted given the health of the economy and the inflation outlook,” he said.

Mapa nonetheless said that prior to the Russia-Ukraine war, “last year was a different story and the BSP was right in keeping accommodation to support growth.”

As for Security Bank Corp. chief economist Robert Dan Roces, “the environment locally is different from the US, so the prudence that [the Philippines] exercised in terms of stimulus affords the BSP enough elbow room to be behind the curve in the meantime, unless inflation grows too fast.”

“Supporting growth recovery is the top agenda, and inflation is a detriment, so without slowing down the recovery too much, I think the BSP is doing a balancing act to be able to do both—rein in inflation while supporting recovery,” he said.