BSP cuts overnight rates by 50 basis points

The Bangko Sentral ng Pilipinas (BSP) cut its key policy rates by 50 basis points yesterday, joining for the first time worldwide efforts to contain the economic fallout of the global financial crisis.

The Monetary Board, the policy-setting body of the BSP, lowered its overnight borrowing rate to 5.5 percent and its overnight lending rate to 7.5 percent in an effort to stimulate the local economy.

The move followed aggressive rate cuts elsewhere, including the US Federal Reserve’s move towards zero rates earlier this week.

Although the market was widely expecting at least a 25-basis point cut, analysts said yesterday’s monetary policy easing reflected a more aggressive stance especially after monetary officials raised concerns over lingering inflation fears.

BSP Governor Amando Tetangco Jr. said the MB based its decision on the latest baseline forecasts which reflected a decelerating inflation path.

He said inflation – a broad measure of the increase in prices of basic goods - is expected to fall within target by 2010 when the government pegged its official target inflation range at 3.5 percent to 5.5 percent.

“This outlook is supported by the downward shift in the balance of risks following the easing of commodity prices, the moderation in inflation expectations and the expected slowdown in economic activity,” Tetangco said.

He said the MB is still wary of remaining upside risks to inflation including the tight demand-supply conditions in the global commodities market as well as the pass-through effect of the weaker peso on retail prices.

Further, Tetangco noted that core inflation - which strips out items exhibiting highly volatile price movements - is still elevated and monetary officials are still waiting for this indicator to go down following the trajectory of the headline inflation which had softened as oil prices fell.

Tetangco said the BSP is hopeful the rate cuts would stimulate lending by reducing borrowing costs. “Hopefully this would also stimulate consumer spending,” he said.

BSP Deputy Governor Diwa Guinigundo said the half-percentage reduction was “sufficient at this point.”

According to Guinigundo, the declining inflation rate gave the MB enough room not only to cut policy rates but to cut them by 50 basis points. “Because inflation is coming down, we can now afford to look at the economy,” he said.

However, he said economic stimulation by easing monetary policy rates would only go so far and the rest of the strategy would still have to be completed, specifically by raising fiscal spending to prime the economy.

Based on the information currently available, Guinigundo said the inflation rate would fall back within the official target by 2010 and this, he said, would allow the BSP the space to provide room for the economy to grow.

UBS economist Edward Teather said UBS expected either a 50-point cut, or a 25-point cut augmented by liquidity enhancing measures such as a reduction in Special Deposit Account (SDA) access or reduced reserve requirements.

According to Teather, UBS originally expected the BSP to keep its policy settings steady until there were clearer signs that inflation rate and the de-leveraging pressures on the currency had abated.

“Now several factors have come together to change our mind,” Teather said.

First, Teather said the price data has shown lower food and energy prices meaningfully impacting the inflation figures.

Headline inflation fell to 9.9 percent in November, below consensus and back into psychologically important single digits. Given recent commodity price declines, he said this data pointed to further sharp falls in coming months.

“We look for inflation to average three percent in 2009 and 3.8 percent in 2010,” Teather said.

He said the November data, combined with the announcement of a higher 2010 inflation target, made it even more likely that inflation expectations for 2009 and 2010 would decline towards their respective inflation targets, spurring the case for lower policy rates.

“Secondly, the dataflow on activity has worsened in a way that is hard for policy makers to ignore,” Teather added.

Moreover, Teather said a rate cut this month was made even likelier by the need to respond not just to lower inflation risks but also growth concerns. He said central banks across the region and further a field have reduced policy rates.

Finally, Teather said that while a weaker peso is a concern for the BSP, the currency had actually gained ground against the dollar in recent trading and had been comparatively stable in trade weighted terms in the last month.