Policy rate cut likely, says DBS Group study

The likelihood of a policy rate cut is increasing considering recent moves by the Bangko Sentral ng Pilipinas to address possible excessive inflows of speculative capital as well as the continued strengthening of the peso.

DBS Group said in a research note that lower rates can serve as additional insurance to support domestic demand in a difficult global economic environment. That is, additional to benign inflation, which averaged at 3 percent year on year for the first semester.

The financial services provider believes that full-year inflation will likely settle at the low end of the BSP’s target range of 3 percent to 5 percent.

On the other hand, DBS said that based on a real effective exchange rate, the peso is already nearing a 15-year high and exporters may get hit by a double whammy of weak external demand and a loss of competitiveness.

“We have consistently highlighted that the authorities have leeway to respond via monetary policy if needed,” DBS said.

“Moreover, cutting rates may reduce speculative inflows and prevent excessive currency strength,” it added.

The Singapore-based group observed that the BSP had taken steps to reduce speculative inflows by restricting foreign funds from investing into its special deposit account, which is an instrument used to absorb excess liquidity in the domestic market.

Earlier this month, monetary authorities decided to require banks to submit a certification that SDA funds belong only to Philippine residents.

Last week, the BSP moved further by reducing the interest rates for SDAs by 3.125 basis points for all tenors.

The one-week SDA rate was cut to 4.03125 percent, the two-week rate to 4.09375 percent, and the one-month rate to 4.15625 percent.

Also, the BSP said banks that do not comply with the new SDA requirements will be denied access to the facility.

“These efforts may not be enough to stem speculative inflows and we think that there is an increasing chance that BSP may lower rates to reduce the attractiveness of local assets and temper peso strength,” DBS said.

“Although not our core view, the recent noticeably dovish rhetoric by the central bank suggests that risks of a rate cut are mounting,” it added.

This runs counter to DBS projections expressed in the past few months, when it said policy rates would stay unchanged for the rest of the year and may increase in the second quarter of 2013.