THE Bangko Sentral ng Pilipinas (BSP) is facing a critical decision on whether to cut interest rates at its upcoming meeting on August 15. With inflation breaching the two to four percent target band in July, BSP Governor Eli M. Remolona, Jr. has indicated that a rate cut is now “a little bit less likely.” This cautious stance comes as headline inflation accelerated to 4.4 percent in July from 3.7 percent in June, marking the fastest inflation rate in nine months.
Governor Remolona’s comments highlight the delicate balance the BSP must maintain between controlling inflation and supporting economic growth. The July inflation figure, which was slightly worse than expected, underscores the challenges faced by the Bangko Sentral. While the base effect contributed 0.3 percentage points to the 4.4 percent inflation print, the underlying inflation rate of 4.1 percent still exceeded expectations.
But the BSP’s decision may also hinge on the just-released economic data. As of August 8, 2024, the economy grew by 6.3 percent in the second quarter of 2024. This growth rate is higher than the 5.8 percent recorded in the first quarter of 2024 and significantly better than the 4.3 percent growth in the same period last year. The increase was driven by strong performances in the industry and services sectors while agriculture, forestry, and fishing faced challenges due to El Niño. With the latest GDP numbers, the BSP must tread carefully to avoid derailing economic momentum.
Adding to the complexity is the global economic environment. Governor Remolona noted that the US Federal Reserve is expected to cut rates in September, which could influence the BSP’s decision-making process. The Fed’s potential rate cut, driven by concerns over the labor market, has already caused global stock markets to plunge.
The BSP has raised borrowing costs by a cumulative 450 basis points from May 2022 to October 2023, bringing the key rate to a 17-year high of 6.5 percent. With the next policy-setting meetings scheduled for October 17 and December 19, the BSP remains open to off-cycle moves if necessary.
What are the potential impact of a rate cut? In summary, while a rate cut can provide a much-needed boost to economic growth, it comes with risks such as potential inflationary pressures and currency depreciation.
Lower interest rates reduce the cost of borrowing, encouraging businesses to invest and expand. This can lead to increased economic activity and job creation. Cheaper loans can boost consumer spending on big-ticket items like homes and cars, further stimulating the economy.
While a rate cut can stimulate growth, it can also lead to higher inflation if demand outpaces supply. This is a delicate balance the BSP must manage, especially given the recent breach of the inflation target.
Lower interest rates can lead to a weaker peso as investors seek higher returns elsewhere. This can make imports more expensive, potentially adding to inflationary pressures. On the flip side, a weaker peso can make Philippine exports more competitive, benefiting the trade balance.
Lower rates can be positive for the stock market as cheaper borrowing costs can improve corporate profitability and investor sentiment. Bond prices typically rise when interest rates fall, benefiting bondholders.
Lower interest rates can reduce the cost of servicing existing debt for both the government and private sector, freeing up resources for other expenditures.
Savers may see lower returns on their deposits, which could discourage saving and encourage spending or investment in higher-yielding assets. Investors might seek higher returns in riskier assets, such as stocks or real estate, potentially leading to asset bubbles if not managed carefully.
A rate cut can signal the central bank’s commitment to supporting the economy, boosting overall confidence among consumers and businesses.
In this complex economic landscape, the BSP’s cautious approach reflects the need to balance multiple factors. The central bank’s flexibility and responsiveness to evolving economic conditions will be crucial in navigating these uncertain times.
