MONDAY MACRO: After 18 months of unchanging interest rates, the Bangko Sentral ng Pilipinas has now begun its rate hikes, increasing rates to 2.25%
On November 20, 2020, the Bangko Sentral ng Pilipinas (BSP) decided to cut the interest rates by 25 basis points (bps) from 2.25% to 2% to stimulate economic activity during the pandemic. Eighteen months later, on May 20, 2022, the BSP did the opposite by increasing the interest rates from 2% to 2.25%.
The BSP now aims to address the surging inflation in the country through the interest rate hike. With this, how will the increase in interest rates tame rising inflation?
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Central Banks manage interest rates to control the supply of currency and ensure price stability. In the Philippines, the Bangko Sentral ng Pilipinas (BSP) makes use of the Overnight Reverse Repurchase Rate (RRP) as the main policy interest rate.
To achieve price stability, the BSP adopted an inflation targeting framework in January 2002. During instances when the inflation rate forecast is lower than the target range, the BSP adjusts the overnight RRP lower to bolster the economy and increases interest rates when the forecast of inflation exceeds the target.
Before the pandemic, the key policy rate ranged from 3% to 4.75%. As the Philippine economy suffered during the pandemic, the BSP cut interest rates by 50bps each in March 2020, April 2020, and June 2020.
One final 25bps cut was done in November 2020. At 2%, the key interest rate was at an all-time low, which was meant to encourage economic activity and boost the economy as a result of the tightening credit standards of banks and decreasing confidence of borrowers during the pandemic.
The BSP maintained that 2% rate for eighteen months.
On May 20, 2022, the BSP decided to hike interest rates by 25bps, increasing the overnight RRP from 2% to 2.25%.
With the 4.9% inflation in April exceeding the BSP’s target of 2% to 4%, the central bank decided it was time to increase rates to manage inflation amidst a rapidly improving economy. In addition, the monetary board forecasted a 4.6% inflation in 2022, higher than the initial 3.7%, as a result of the increasing oil and food prices, and adjustments in the minimum wage for some regions. BSP Governor Benjamin Diokno sees that the inflation rate could go beyond 5% in the next few months before going back to its target in mid-2023.
While the increase in interest rates implies a higher cost of borrowing, this also signals the central bank’s confidence in the improving economy. Philippine GDP growth has been steadily rising since 2021, and with most of the country under the lowest quarantine alert level, it is likely that even with the slightly higher interest rate, we will continue to see GDP grow.
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