Monetary Policy Remains Accommodative as Inflation Eases in Q2 2021

​The BSP releases the quarterly BSP Inflation Report covering the period April-June 2021. The full text of the report is being released in PDF format on the BSP website (https://www.bsp.gov.ph/SitePages/MediaAndResearch/Inflation%20Report.aspx). The BSP Inflation Report is published as part of the BSP's efforts to improve the transparency of monetary policy under inflation targeting and to convey to the public the overall thinking and analysis behind the Monetary Board's decisions on monetary policy.

The following are the highlights of the Q2 2021 BSP Inflation Report:

• Average headline inflation eases in Q2 2021. Year-on-year (y-o-y) headline inflation declined to an average of 4.3 percent in Q2 2021 from 4.5 percent in the previous quarter. On a year-to-date basis, average inflation was higher than the National Government's (NG) 2-4 percent target for the year. Lower food inflation, attributed mainly to the decline in the prices of rice, fruits, and vegetables, along with the normalization in supply, led to the slower inflation during the quarter. Meanwhile, non-food inflation rose as higher petroleum prices drove transport prices. Meanwhile, core inflation decelerated to 3.2 percent in Q2 2021 from 3.5 percent in the previous quarter, while preliminary estimates of alternative core inflation measures produced by the BSP exhibited mixed trends.

The BSP's survey of inflation expectations of private sector economists as of June 2021 indicates a lower mean inflation forecast for 2021 and higher mean inflation forecasts for 2022 and 2023 relative to the March 2021 survey. For 2021, analysts see the risks to the inflation outlook as tilted toward the upside owing to potential supply disruptions, rising global crude oil prices, the positive impact of the continued rollout of vaccines on domestic demand and economic activity, and base effects. Meanwhile, downside risks to inflation are linked mainly to subdued domestic demand due to reduced purchasing power and the continued implementation of quarantine restrictions. Favorable weather conditions and the timely government interventions to ease food supply constraints are also expected to help alleviate price pressures.

• The domestic economy posts a smaller contraction in Q1 2021. Real gross domestic product (GDP) declined by 4.2 percent year-on-year in Q1 2021 following an 8.3-percent drop in Q4 2020. On the production side, the decline in Q4 2020 was attributed to smaller output contractions in the industry, services, and agriculture sectors. On the expenditure side, private consumption remained weak but showed signs of improvement. Similarly, investments and external demand recorded slower contractions relative to Q1 2021, while government consumption continued to expand.

High-frequency indicators pointed to a recovery in domestic demand. Property prices in the main business districts of the National Capital Region (NCR) have continued to decline, while residential property prices outside the NCR went up. New vehicle sales and energy sales also improved. The manufacturing volume of production index rose in April with expansion observed in a majority of sub-sectors. Likewise, average capacity utilization rose slightly in April as both volume and value of production orders in the manufacturing sector grew. Following a 15-month contraction, the composite Purchasing Managers' Index (PMI) returned to expansion territory in May 2021. Meanwhile, business sentiment was less optimistic for Q2-Q3 2021 due mainly to the continuing increase in COVID-19 cases and the reimposition of stricter community quarantine protocols, and the elevated inflation environment.

• ​Global economic activity exhibits signs of recovery. Real GDP in the US, China, and India expanded at a faster rate in Q1 2021, while euro area output contracted at a slower pace, relative to Q4 2020. Recent PMI readings in these economies, except for India, also reflected signs of recovery in demand conditions.
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• The domestic financial system remains sound. Demand for government securities remained robust amid ample liquidity in the financial system. The peso appreciated, supported by easing headline inflation and improvements in activity indicators. Meanwhile, the Philippine Stock Exchange Index declined as market concerns on rising cases of the new virus variant and the possible reimposition of stricter quarantine measures in NCR and adjacent provinces dampened prospects for recovery.

Meanwhile, in the credit market, the preliminary results of the latest BSP senior loan officers' survey indicated a general tightening in credit standards during Q2 2021. Responses to the survey were collected during the government's reimposition of stricter quarantine measures to moderate the spread of COVID-19 infections. Nevertheless, the Philippine banking system continued to exhibit resilience and stability in Q2 2021 as loan exposures remained adequately covered.

• ​​The BSP maintains its monetary policy settings in Q2 2021. The BSP decided to keep the interest rate at 2.0 percent for the overnight reverse repurchase (RRP) facility in its meetings on 12 May and 24 June 2021. Latest BSP inflation forecasts indicate that average inflation is likely to settle near the upper end of the Government's 2-4 percent target range in 2021 before easing towards the midpoint of the target range in 2022 and 2023. The continued implementation of direct non-monetary interventions to alleviate supply constraints shall be crucial in tempering pressures on meat prices and inflation.

Meanwhile, the balance of risks to the inflation outlook remains broadly balanced around the baseline projection path over the policy horizon. The uptick in international commodity prices due to supply-chain bottlenecks and the recovery in global demand could lend upside pressures on inflation, while the emergence of new coronavirus variants and delays in the easing of containment measures are seen to pose downside risks to both demand and inflation.

At the same time, the overall pace of recovery remains tentative amid the continued threat of COVID-19 infections. In this regard, the continued implementation of targeted fiscal initiatives as well as the acceleration of the Government's vaccination program should facilitate the gradual reopening of the economy and thus strengthen market confidence.

Given these considerations, the BSP believes that the monetary policy stance will need to remain accommodative for as long as necessary in order to ensure the recovery of the economy. Sustained monetary policy support should help the economic recovery gain more traction, especially as risk aversion continues to temper credit markets and overall activity. Looking ahead, the BSP will remain vigilant against any emerging risks to the outlook for inflation and growth in order to ensure that monetary policy settings remain in line with its price and financial stability mandates.

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