Deutsche Bank sees BSP further raising key rates

The Bangko Sentral ng Pilipinas (BSP) may raise benchmark rates by 100 basis points over the next four quarters as the rate hike last month was not enough to curb inflationary pressures, according to German investment bank Deutsche Bank.

In a report, Deutsche Bank chief economist in Asia Michael Spencer said the expected rate increases would bring the overnight reverse repurchase rate to 3.5 percent in the second quarter, 3.75 percent in the third, four percent in the fourth, and 4.25 percent in the first quarter of 2019.

The central bank lifted benchmark rates by 25 basis points for the first time in more than three years last May 10, bringing the overnight reverse repurchase rate to 3.25 percent.

“Last month’s rate hike seems not to have improved market sentiment, with the currency continuing to depreciate. We expect this to continue, albeit at a slower pace by year-end, and with inflation risks to the upside we expect at least four more rate hikes from BSP this cycle,” Spencer said.

Inflation accelerated to a fresh five-year high at 4.6 percent in May, bringing the average to 4.1 percent in the first five months. The BSP has set an inflation target of two to four percent this year and next year.

Spencer said policymakers have in recent months gone to great lengths to explain the sources of inflation, to reassure people that they are working to lower it and to explain how.

“But we fundamentally disagree with their diagnosis. The policymakers ascribe the rise in inflation mainly to supply-side factors. We think it is a demand-side, overheating phenomenon,” the economist said.

According to Spencer, the rising inflation points to overheating phenomenon for which tighter monetary or fiscal policy would be appropriate even if lower rice and fuel prices help bring inflation back into the BSP’s target band over the next few quarters.

“We worry that policymakers are acting too slowly to address this. Indeed, with inflation having risen by 1.7 percentage points since the end of last year, but with policy rates only 25 basis points higher, real interest rates have fallen to their lowest levels in nearly three years. Monetary policy is not getting tighter, if anything, it’s getting easier,” Spencer said.

The economist said the liberalization of rice imports could dampen inflation.

Furthermore, Deutsche Bank said the decision of the BSP to further trim the level of deposits banks are required to keep with the central bank confused the market.

The BSP has slashed the ultrahigh reserve requirement ratio to 18 percent last June 1, releasing an additional liquidity of P190 billion into the financial system.

“And while we understand, and agree with, the justification for cutting the reserve requirement two weeks later, the latter decision has confused some investors by raising questions as to the central bank’s resolve to tighten liquidity,” he said.

Deutsche Bank expects inflation to accelerate to 4.7 percent this year before easing to 4.2 percent in 2019. It also sees the Philippine economy growing by a slower 6.3 percent this year.