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Interest rates could rise in early-2017 -- analysts

Posted on September 24, 2016

THE BANGKO SENTRAL ng Pilipinas (BSP) may find room to hike interest rates within next year’s first half, according to two analyses published Friday, one of which cited a possible need to prevent the economy from overheating as the government cranks up spending.

In separate reports, economists at DBS Bank and ANZ Research said monetary authorities may be poised for a rate hike within the first half of next year, after they kept policy steady in their Thursday meeting in the face of subdued inflation and robust domestic activity.

A third report -- by London-based Capital Economics Ltd. -- cited concern over rising loans to the property sector, but clarified that even this development has not been enough, so far, to change its expectation of a stable monetary policy “to the end of 2017.”

The Monetary Board kept policy settings steady at 3.5% for the overnight lending rate, 3% for the overnight reverse repurchase rate, and 2.5% for the overnight deposit rate at its sixth review for the year, keeping the operational tweaks that took effect in June as the central bank migrated to an interest rate corridor. Reserve requirement ratios were also unchanged.

This came after the US Federal Reserve and the Bank of Japan both opted to keep interest rates steady this week, although the former signaled a rate hike was in the cards within the year -- which could send capital now parked in emerging markets like the Philippines flowing back to the world’s biggest economy.

The BSP last made actual adjustments to monetary policy -- by raising key interest rates -- in September 2014.

“[T]here is every reason for the BSP to be comfortable with its current policy stance. Domestic demand is firm while inflation remains below target. Yet, we also reckon that the central bank is prepping itself to gradually tighten policy,” DBS Group Research said in its report.

DBS Bank said the BSP may consider matching the government’s plan to significantly ramp up public spending with a rate hike to prevent the economy from overheating, which happens when businesses overproduce in anticipation of overestimated rising demand.

“As the Duterte’s administration steps up its budget deficit target to 3% of GDP (gross domestic product) in 2017, the BSP may need to balance by adjusting rates higher to avoid overheating the economy in the short term,” the report read.

“The next move from the BSP set to be a hike, happening in early-2017.”

In particular, the Singapore-based lender expects the BSP to raise the 3% benchmark rate by 25 basis points twice within the first semester of 2017, to end at 3.5% by June.

ANZ economist Eugenia Fabon Victorino said in a separate report that she expects a hike in BSP’s policy rates towards the end of next year’s second quarter, noting that such a move will be timed with the turnout of the central bank’s term deposit auctions.

Term deposit facility (TDF) auctions are the central bank’s main tool to arrest excess liquidity in the financial system and influence market rates besides, by prodding them closer to the BSP’s 3% benchmark.

“Until most of the excess liquidity migrates to the TDF windows, we do not expect any adjustment in the central bank policy tools. For now, we are still pencilling in interest rates hikes to commence at the end of Q2 2017,” Ms. Victorino said in a market commentary.

The BSP has consistently hiked the auction volumes per month, with P110 billion to be offered by Oct. 5 just as the yields fetched under the 28-day tenor continue to trend higher than the 2.5% floor rate. Wednesday’s auction fetched a 2.528% yield.

In the Sept. 22 issue of its Emerging Asia Economics Update, Capital Economics said there has not been any sign, so far, that the economy is on the verge of overheating.

Noting that the Philippine economy grew by a three-year peak of 6.9% last semester -- against the government’s 6-7% full-year projection for 2016 -- on the back of strong investments, household consumption and spending related to the May 9 national elections, Capital Economics noted that “there is little sign that strong growth is feeding through into an increase in inflation” which averaged 1.5% in the eight months to August, against an official 1.7% full-year forecast that had been cut twice, so far.

“Although the recent election of Rodrigo (R.) Duterte as president has made the outlook more uncertain, barring any sudden change in policy direction the economy should continue to grow strongly over the next couple of years,” Capital Economics said in its note.

Analysts have increasingly flagged uncertainty stoked by Mr. Duterte’s bloody war against the illegal drug trade and his outbursts against strategic and economic allies like the United States and the European Union, as well as the United Nations, over concerns raised over possible human rights violations.

S&P Global Ratings last Thursday affirmed the Philippines’ investment-grade credit rating anew in the face of robust domestic activity and sound fiscal footing, but flagged “rising uncertainties” under the newly installed Duterte administration and said “a higher rating is unlikely” in the next two years.

“One area for concern is the recent acceleration in credit growth, which if sustained, could put the health of the financial sector at risk,” Capital Economics said.

“We are particularly concerned about an increase in lending to the property sector.”

The total real estate exposure of universal, commercial, and thrift banks hit P1.554 trillion as of end-March, rising by 22.1% from the P1.273 trillion posted a year ago on the back of higher property loans and investments poured in by households and property firms, according to latest available BSP data. For the entire 2015, such exposure rose 24.1% to P1.516 trillion from 2014’s P1.221 trillion.

“That said, the central bank has traditionally preferred to manage these risks through the use of macroprudential measures, and we doubt stronger credit growth will be the trigger for the BSP to raise rates,” the noted added.

“We expect the BSP’s will leave its key policy rate unchanged at 3.0% not just for the rest of this year, but to the end of 2017 as well.”

BSP Deputy Governor Diwa C. Guinigundo said last Thursday that future policy decisions will remain data-driven.

“We are not focused only on monetary and price conditions. We do not consider only what the Fed is going to do in terms of normalizing monetary policy in US, but we monitor a host of other factors including growth dynamics, financial market developments, spillover effects in terms of capital flows, so it depends on what kind of data we will be looking at next [meeting],” Mr. Guinigundo told reporters after Thursday’s policy meeting.

The Monetary Board will again review policy settings on Nov. 10. -- Melissa Luz T. Lopez