BSP hikes interest rates for first time in 5 years

For the first time since October 2000, the Bangko Sentral ng Pilipinas (BSP) raised key overnight interest rates by 25 basis points yesterday, firing what it called a "warning shot" to head off mounting inflationary pressures in the next 14 months.

The BSP brought overnight borrowing rates to seven percent while overnight lending rates were raised to 9.25 percent.

The BSP said inflation pressures "remain limited at the moment," adding that their latest forecasts show inflation declining to four to five percent by 2006.

"However, the upside risks for inflation outlook have increased given prevailing expectations for international oil prices which are expected to remain high," the BSP said.

The consumer price index rose 8.5 percent in March, the same rate as in February, because of higher prices for oil products and certain foodstuffs.

The BSP said the inflationary expectations have changed since its last policy rate-setting meeting, admitting for the first time that demand-side pressures are beginning to emerge.

BSP Deputy Governor Amando M. Tetangco told reporters that demand-side pressures are "still weak but already present," although supply-side pressures still dominated the causes for the surge in the national average inflation rate.

Tetangco said the move was a "warning shot" but said it was not an indication of further tightening in monetary policies in the next few months.

"It’s still way too early to tell," Tetangco said. "This situation is not static and we have to keep looking at the situation to see how our prices are holding up against all these risks and pressures."

Tetangco said the 25- basis point increase was considered a warning shot because the expected impact on domestic rates was marginal.

"A twenty-five basis-point adjustment is not so significant in terms of impact on lending rates," Tetangco said. "But its more of a pre-emptive step against inflation expectations spiraling away from the target."

"The effects of demand pressures are still limited at this time so the main source of inflationary pressures continues to be supply-side," he went on. "But the expectations have started to go up and these are obviously risks to inflation."

According to Tetangco, the risks are coming mainly from continued high prices of oil and these would have an effect on pricing decisions later on.

"We looked at commodities whose prices have gone up over the inflation target and the number of commodities have increased compared to first quarter of last year," Tetangco said.

According to Tetangco, this was an early indication that, unless monetary action was taken, the inflation could become broad-based.

Tetangco said the BSP also considered the calibrated increases in US interest rates. "As long as the interest rate differential is still in excess of 200 points, the expectation is that the US Fed will continue to tighten in the future."

According to Tetangco, the MB decided not to touch its liquidity reserve requirements for banks because there was no significant movement in domestic liquidity given the persistently high unemployment rate and slight excess capacity in the manufacturing sector.

"Under these circumstances, the MB believes that a measured increase in policy interest rates can help prevent rising inflationary expectations from becoming widespread and entrenched and prevent on-going supply shocks from generating second-round effects," Tetangco said.