Nomura sees BSP raising key interest rates by another 100 basis points

The Bangko Sentral ng Pilipinas may hike its key interest rate by 100 basis points more this year—beginning with a 50 basis point hike during its monetary setting today—to curb rising inflation, Japanese investment house Nomura said.

In a research note dated Aug. 7, Nomura said that after hitting a five-year high of 5.7 percent year-on-year in July, inflation rate in the Philippines might not peak until September or October this year.

Citing more supply side pressures in the pipeline and a still rapidly expanding economy, Nomura raised its inflation forecast this year to 4.9 percent from 4.6 percent. The inflation forecast for next year was also raised to 3.7 percent from 3.5 percent.

Aside from the expected hiking of its overnight borrowing rate by 50 basis points to 4 percent today, Nomura said the inflation-targeting BSP would likely remain vigilant of upside risks.

“The drivers of inflation have clearly broadened, which would be seen by the BSP as a sign of more second-round effects alongside recent demands for wage and transport fare hikes,” the research said.

Nomura also expects another 50 basis points of policy rate hikes —one quarter-percentage point in each of the next two meetings in September and November—taking the policy rate to 4.5 percent by the end of the year.

“A cumulative (additional) 100 basis points of rate hikes this year would help ameliorate market concerns over rising inflation and would be peso-positive,” it said.

During the policy setting today, Nomura said the market would be closely watching not just the pace of increase but the associated rhetoric. “A smaller hike or commentary indicative of limited tightening ahead would likely be viewed negatively by the market and could lead to another bout of Philippine peso weakness,” the research said.

Meanwhile, Nomura noted that the BSP’s September monetary setting would coincide with the next Federal Open Market Committee meeting, at which the US central bank was likewise widely expected to raise interest rates.

“Even if headline inflation starts to ease from there, inflation expectations will likely take longer to adjust. The real policy rate also remains negative (we expect CPI inflation to end the year at around 5 percent), necessitating another move by the BSP in November,” Nomura said.

“As we have argued before, with the BSP increasingly citing the currency as adding to inflation risks, real rates would be an important policy consideration for BSP to tighten further to contain capital flow pressures against the widening current account deficit and a weaker external backdrop,” it added.

The main risk to Nomura’s view of a more hawkish BSP is a sharp electronics downcycle that can hurt exports and hence growth. That said, Nomura said fiscal policy remained highly expansionary and the government remained focused on implementing infrastructure projects. This is seen to boost domestic demand and offset the impact of slower exports, as has already been the case so far this year.

It’s also possible that inflation will undershoot its new forecasts, Nomura said, such as if there would be supply shocks like a sharp fall in oil prices.

The BSP expects the rice “tariffication” bill—which has been certified by President Duterte as “urgent” in the legislative agenda and thus increasing the likelihood of its enactment within the year—to lower headline inflation. However, Nomura said there was still a high degree of uncertainty around this bill, not just in terms of the exact timing of its passage.

“We still have to wait to see what form the law will take, particularly the tariff rate that will replace import quotas (such as whether the Asean tariff rate of 35 percent will be adopted or a much higher rate to help support local farmers). In addition, large-scale rice importation will likely take time and would add to the current account deficit, which would in turn hurt the currency and thus partly offset the disinflationary effect expected by the BSP from the increase in rice supply,” it said.