Financial markets outlook positive as inflation eases, in line with expectations

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By Mark T. Amoguis, Senior Researcher

THE FURTHER EASING in domestic inflation buoyed investor sentiment for much of the first quarter this year even as upside risks — mostly from the external front — remain.

In the first three months of the year, headline inflation slowed to 3.8% compared to 5.9% in the fourth quarter of 2018 according to data from the Philippine Statistics Authority. The 3.8% first-quarter average is now within the 2-4% target range by the central bank.

The first-quarter deceleration, according to the Bangko Sentral ng Pilipinas’ (BSP) first-quarter inflation report, reflects mainly the slowdown in food inflation amid improved supply conditions.

The inflation slowdown was mostly broad-based with much of the downtrend seen in the heavily weighted food and non-alcoholic beverages index at 4.6% in the first quarter versus the 8% in the fourth quarter of 2018. Food alone averaged 4.1% in the January-March period against the 7.7% average in the preceding quarter.


With the decelerating inflation, analysts that time have said that the conditions are ripe for policy easing. The BSP’s Monetary Board, however, maintained benchmark rates and the banks’ reserve requirement ratio (RRR) in its first and second policy reviews on Feb. 7 and March 21 albeit cutting their headline inflation forecast for the year by a tenth of a percentage point in each of those meetings to a flat three percent from 3.2%.

It was in its May 9 meeting when the BSP slashed key policy rates by 25 basis points (bps). A week later, it announced cuts in RRR imposed on big banks in three phases: 100 bps by May 31, 50 bps by June 28, and 50 bps by July 26.

The central bank also revised lower its inflation forecast this year to 2.9% (from three percent previously) and hiked next year’s forecast to 3.1% (from three percent).

The bellwether Philippine Stock Exchange index (PSEi) peaked during the quarter at 8,144.16 on Feb. 1, to which the BSP attributed mainly to the slower-than-expected domestic inflation in December as well as the US Federal Reserve’s dovish stance on its first policy meeting this year, and the perceived easing trade tensions between the US and China that time. However, the delayed enactment of the 2019 fiscal budget as well as the concerns in global economic growth and the growing uncertainty over the US-China trade tensions caused the index to decline to end the quarter at 7,920.93.

Nevertheless, the end-quarter reading marked a 6.1% increase compared to the 2.6% growth in the fourth quarter of 2018 and the 6.8% drop in the first quarter of 2018.

Gains were also made in the money and bond markets as the peso appreciated for much of the quarter while bond yields declined.

The same three months brought the value of the peso up with the currency averaging P52.37-to-a-dollar versus the P53.26-per-dollar average from the previous quarter, according to BSP data.

As of end-March, yields on government securities (GS) declined on average by 111.8 bps relative to the end-December 2018 levels as GS yields in the secondary market for all tenors declined except for that in the 91-day debt paper, according to the PHP Bloomberg Valuation Service (BVAL) Reference Rates published on the Philippine Dealing System’s website.

During the quarter, GS debt yields were lower by a range of 57.4 bps for the 182-day GS to 167.2 bps for the 20-year GS compared to yields in end-December 2018.

“Developments in 2019 were similar to those faced by the Philippines in 2018 but in reverse polarity,” ING Bank NV Manila Branch senior economist Nicholas Antonio T. Mapa said in an e-mail.

On the local front, Mr. Mapa said that while inflation — considered as the “bane of 2018” — is on a decelerating trend, government spending “disappeared after supporting growth in 2018,” which resulted in “disappointing” economic growth in the first quarter.

Economic growth grew at a four-year-low 5.6% in the first quarter. Largely blamed for this was the slowdown logged by government spending, which in turn was blamed on the delay in passing the 2019 fiscal budget. The government operated on a reenacted 2018 budget from the start of the year until April 15, when President Rodrigo R. Duterte signed the latest general appropriations into law, but vetoed P95.3 billion in appropriations.

On the external front, the economist also noted the turnaround in the monetary policy stance of the Federal Open Market Committee (FOMC), the US Fed’s policy-making body.

“[T]he FOMC suddenly halted its rate hike march, now seen to be on hold for rest of the year,” Mr. Mapa said.

“Possibly the only development that was not in reverse was oil prices, which climbed sharply from January levels, but this still has had limited effect on inflation and thus also only a marginal impact on [foreign exchange] and fixed-income securities,” Mr. Mapa added.

Moving forward, economists are betting that inflation could even go lower this year due to base effects.

“Inflation in 2Q 2019 may ease further to 2%-3% in 2Q 2019 and could even average below 3% in 2019, largely due to the continued decline in food prices… even before the full effects of the Rice Tariffication Law are felt in terms of further increase in rice imports,” said Rizal Commercial Banking Corp. (RCBC) economist Michael L. Ricafort in an e-mail.

For Sun Life Financial economist Patrick M. Ella: “I still fully expect inflation to remain lower than [the first quarter] and I would not be surprised if it will break under 3% by June,” he said in a separate e-mail.

“For the balance of the year, we think inflation can reasonably touch close to 1% by [third quarter] before turning up as the base effects are responsible for this as well as the absence of inflationary pressures in the food and energy prices.”

ING Bank’s Mr. Mapa was of a similar view: “Even with oil prices surging, we still see inflation hovering about the 3% target and with the Philippines now touting its single best inflation fighter in history (i.e. the rice tariffication law), we can expect this to be an integral part of keeping cost push inflation in check for the time being.”

The government signed the Republic Act No. 11203 — the rice tariffication law — last February to curb rising food prices by removing quantitative restriction on rice imports and replacing it of tariffs.

Similarly, economists expect the economy to grow within target despite the first-quarter letdown.

“Despite the Q1 snafu, the budget passage will mean that growth in [the second half] will receive a substantial boost. Household spending continues to recover while the BSP rate cut (and further easing) are seen to help revive slowing capital formation,” ING’s Mr. Mapa said.

“The 6%-7% GDP growth target for 2019 may still be achieved amid the country’s improved economic and credit fundamentals, as well as the country’s favorable demographics,” RCBC’s Mr. Ricafort said.

Here are the economists’ forecasts on the financial market this year:

ING’s Mr. Mapa: Positive as GDP recovers.

Sun Life’s Mr. Ella: Our equities team has a bottom-up PSEi index target of 8,750, which is a 17.2% upside from 2018. This implies a P/E (price-to-earnings ratio) of 18.4 times and earnings growth expected at 11.7% for 2019.

RCBC’s Mr. Ricafort: Further declines in both inflation and interest rates would fundamentally increase net profits/income of listed companies, assuming all other factors are the same, thereby may support higher valuations.

Any further increase in foreign portfolio inflows after the S&P credit rating upgrade on the country may also provide support for the local equities market.

ING’s Mr. Mapa: Yield curve to normalize on BSP rate cuts and RRR reductions.

Sun Life’s Mr. Ella: Fixed income will likely see lower yields in response to the BSP that is on a clear easing mode. I’m looking at 5% for the benchmark 10-year bond yield by yearend.

RCBC’s Mr. Ricafort: Continued easing trend in inflation, as well as any further cut/s in local policy rates and any cut in RRR (additional P90 billion in liquidity/money supply infused into the financial system for every 1-percentage-point cut in RRR) may lead to further easing in local interest rate benchmarks, or at least sustain local benchmark yields at relatively lower levels.

The latest S&P [Global Rating] credit rating upgrade on the Philippines by one notch to BBB+ (two notches above the minimum investment grade) would increase international investor confidence on the Philippines in terms of increased inflow of foreign portfolio investments and foreign direct investments into the country, thereby may lead to further gains in the local economy as well as in the local financial markets.

ING’s Mr. Mapa: Depreciation pressure given fundamental C/A (current account) deficit but tactical strength to be seen during times of risk on [sentiment].

Sun Life’s Mr. Ella: our USD/PHP view is at P53.20 and we have not changed this view since the start of the year.

RCBC’s Mr. Ricafort: The peso exchange rate may continue to remain relatively stable, as partly supported by the sustained easing trend in inflation, as well as some narrowing in the trade deficit date since late last year.

Going forward, any pick up in foreign portfolio investments and foreign direct investments after the latest S&P credit rating upgrade may provide some support on the local currency.