What?In line with market expectations, the BSP lowered the benchmark policy ratetoday by a full 50bp. The announcement comes on the back of this morning's4Q GDP release, which showed surprising strength during the quarter of 4.5%yy after an upwardly revised 5% growth rate in the third quarter. This hadstrengthened our belief that the authorities would opt for a more measuredpace of rate cuts. Instead, the BSP brought the policy rate back down to 5%where it stood before the inflation surge in early 2008 and which at thatstage marked already a multi-year low.
In a subsequent press conference, the Deputy Governor of the BSP, stressedthat inflation pressures are easing rapidly. He also emphasized that ratecuts are aimed at encouraging bank lending in the Philippines, an integralpart of the government's strategy to bolster the economy against thegrowing global headwinds. The Deputy Governor, however, underlined thattoday's decision by the central bank was largely pre-emptive, rather thanindicative of any existing stresses on local financial conditions.
So What?We agree with the broad thrust of the central bank's assessment on growthrisks and likely inflation developments. In fact, headline CPI should comein at target both this year and next, which on the surface provides the BSPwith growing head-room to cut rates further. We had pencilled in a cyclelow to 4.5% for the benchmark policy rate and continue to stick by it, eventhough today's more aggressive action suggest some downside to our forecast. All considered, however, a more measured pace in rate cuts may beadvisable. First, remittances are likely to come under growing pressure,something that hasn't fully come the attention of financial markets yet, inour view. This, in turn, might raise risks of growing peso volatility goingforward, against which a more comfortable interest rate buffer wouldprovide useful assurance. Second, the banking system does not appear tosuffer from meaningful liquidity constraints at this stage, with banklending expanding at a healthy double digit pace and bank reserves stillbeing ample. Overall, the Philippine economy has proven remarkably robustin this current global environment, warranting a cautious approach by theBSP to further rate cuts.
Bottom line: Expect at least another 50bp in cuts in this cycle, pushingthe policy rate to historical lows. However, worries over remittances andresulting risks of exchange rate volatility warrant a more measuredapproach to further easing.
Frederic NEUMANNSenior Asia Economist
Global Banking and MarketsThe Hongkong and Shanghai Banking Corporation Limited
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