Converging evidence for monetary policy tightening

By the time this column comes out Friday morning, the Bangko Sentral ng Pilipinas (BSP) must have acted, and acted correctly, by tightening monetary policy by at least 25 basis points (bps). At this stage, the question is no longer whether to move, but whether policy will move fast enough to stay ahead of the curve.

The evidence is not just compelling; it is converging.

What began as a supply shock from geopolitical tensions in the Middle East has now metastasized into an increasingly generalized inflation problem. Higher fuel prices have already worked their way through transport, freight, and logistics, raising the cost structure of virtually all goods and services. Utility price increases are imminent. The restoration of rice tariffs this month, given rice’s nearly 9% weight in the consumer price index, adds a direct and immediate source of upward pressure. These are not temporary disturbances. They are the channels through which supply shocks become embedded in the broader price system.

And that is precisely what is happening.

Evidence shows that indeed second-round effects are no longer a risk, they are underway. Businesses are adjusting prices not just to reflect higher input costs, but in anticipation of further increases. Workers, seeing their purchasing power erode, will soon demand wage adjustments. Once this wage-price dynamic sets in, inflation becomes more persistent and far more difficult to reverse. The window for preemptive action is rapidly closing. This is cause for serious concern.

Expectations are already shifting. Business and consumer sentiment surveys point to weakening outlooks even as prices continue to rise. For both households and business, this is the worst possible combination: slowing growth alongside rising inflation. If inflation expectations become unanchored, the BSP will be forced into a much more aggressive tightening cycle later, one that could impose far greater costs on growth and employment. This is where these recent talks about stagflation are coming from.

For those who would not act unless they see proof, an early warning signal is unmistakable: core inflation. In the first quarter of 2026, core inflation rose from 2.4% to 3%. This is not noise. It is a signal that inflation is broad-ening beyond volatile components and taking root in the underlying structure of prices. Households are spending more not because they are better off, but because everything costs more. This is the anatomy of demand de-struction — an erosion of real incomes that will eventually force consumption to contract.

The uncomfortable truth is that policy has lagged these developments.

The BSP maintained an easing bias in February and paused in March despite the announcement of a 5.1% inflation forecast for 2026 and escalating geopolitical risks. While it is true that monetary policy cannot directly offset supply shocks such as higher oil prices, it is equally true that it must prevent these shocks from spilling over into expectations, wages, and broader price-setting behavior. That spillover is now evident.

Not a few would deny this, but compounding the problem is impaired monetary transmission. In theory, lower policy rates should stimulate borrowing and spending. In practice, banks behave pro-cyclically. In periods of un-certainty like the pandemic of 2020, banks actually tightened credit standards, shortened loan maturities, and demanded stronger collaterals. The result is a paradox: policy rates fell, but effective financial conditions did not ease. Under these conditions, further easing risks fueling inflation without delivering meaningful support to economic growth.

This is not conjecture; it is textbook adverse selection and moral hazard at work. When information is imperfect and risks are elevated, lenders pull back. As a result, the central bank cannot assume that lower rates will translate into higher lending or investment. If anything, the imbalance between liquidity and risk aversion can distort markets further.

At the same time, external constraints are tightening. The interest rate differential with the US Federal Reserve has narrowed following successive BSP rate cuts, increasing pressure on the peso and raising the risk of capital outflows. With inflation forecasts for 2026 rising and remaining elevated into 2027, the room for policy accommodation has effectively been exhausted.

As expected, financial markets have already internalized this reality. Indicators such as credit default swaps suggest rising risk perceptions and a growing expectation of tighter policy. Economists and forecasters, once divided, are now tilting toward rate hikes. The signal is clear: policy credibility is on the line.

The BSP’s mandate for promoting price stability is straightforward. It has already done its part in supporting growth through earlier, successive easing. Even the reserve requirement ratios have been brought down to a single digit, delivering additional liquidity into the system. But the environment has changed, and policy must change with it. Governance issues, fiscal constraints, and global volatility may be outside the BSP’s direct control, but they amplify the consequences of delayed action. In such an environment, anchoring expectations becomes even more critical.

A 25-basis-point increase is therefore not just appropriate, it is necessary. But it must also be understood as only the beginning of a tightening cycle, not a one-off adjustment. The BSP must signal clearly that it is pre-pared to act further if inflation pressures persist.

The geopolitical backdrop reinforces this need for forward-looking policy. The range of possible outcomes, from a relatively short conflict to a prolonged disruption, differs in magnitude but not in direction. Even under a “benign” scenario, oil prices are likely to remain elevated and supply chains disrupted. A more adverse scenario of prolonged conflict, and sustained oil prices above $100, peso depreciation would intensify inflationary pressures and complicate policy choices further.

In other words, uncertainty is not an argument for caution; it is an argument for preparedness.

Monetary policy cannot wait for clarity that may never come. It must act on probabilities, not certainties.

To be sure, the current predicament also reflects deeper structural weaknesses. Overreliance on fossil fuels, the absence of a robust strategic petroleum reserve, limited diversification of trade and investment flows, and per-sistent governance challenges have all increased the economy’s vulnerability to external shocks. Fiscal space remains constrained, not least because of widespread inefficiencies and unprecedented leakages in public spending through unmitigated corruption. These are long-standing issues that require sustained reform, but they also heighten the urgency of credible monetary policy today.

Inflation targeting and central bank independence have served the country well. But they are only as effective as the willingness to act decisively when conditions demand it.

That moment is now.

The BSP must move — not cautiously, not hesitantly, but with clear intent. Tighten today, and be prepared to tighten further if needed. The cost of acting too little, too late will be far greater than the cost of acting early and decisively.

In the end, credibility is the most powerful instrument of monetary policy. It must be used.

Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.