5 reasons why inflation eased in Q2

MANILA, Philippines – Prices of basic commodities and services eased in the second quarter of the year, the central bank reported in its quarterly inflation report Thursday, July 23.

The Bangko Sentral ng Pilipinas (BSP) 55th Inflation Report covering April-June this year showed why inflation in the second quarter was easy on consumers’ spending power:

1. Year-on-year headline inflation decreased further in the previous quarter. Inflation slowing to 1.7% from the quarter- and year-ago rates of 2.5% and 4.4%, respectively. The year-to-date average inflation of 2% remains within the government’s target range of 3% ± 1 percentage point for 2015.

Adequate domestic supply slowed down price increases in most food items, contributing to the continued easing of inflation in the previous quarter. Non-food inflation likewise eased due to lower power rates, and in the prices of domestic petroleum products.

“Similarly, measures of core inflation decreased further during the quarter,” BSP noted.

The June inflation of 1.2% defied analysts’ expectations that it would not go any lower than 1.6%, the record for May 2014, citing strong pressures from the probable impact of drought, poor agricultural harvest, and election-related spending in the coming months. (READ: Philippine inflation unlikely to go lower than 1.6%)

BSP said latest baseline inflation forecasts show that inflation is likely to settle within the lower half of the target range of 3% ± 1 percentage point for 2015 and 2016.

Risks to the inflation outlook continue to be broadly balanced. Meanwhile, downside risks could stem from slower-than-expected global economic activity. Inflation expectations also remain well-contained following recent inflation outturns.

2. Domestic demand conditions remained firm. Real gross domestic product (GDP) expanded by 5.2% in Q1 2015, slower than the government’s growth target of 7% to 8% for the year. GDP is the monetary value of all the finished goods and services produced within a country in a specific time period. (READ: PH GDP growth slows to 3-year low: 5.2% in Q1 2015)

The weaker-than-expected growth in output was due largely to the slower pace of public spending and export growth on the expenditure side, and the deceleration in manufacturing activity on the production side.

“Nevertheless, firm household spending and service sector growth continued to support the economy,” BSP said.

Vehicle sales continued to be brisk, while the Purchasing Managers’ Index (PMI) remained above the 50-point expansion threshold.

Business sentiment also remained broadly optimistic, although consumer confidence weakened on expectations of potential increases in commodity prices,” BSP added.

3. Global economic prospects generally improved.  The outlook across countries, however, continues to diverge. Growth in the US remains on track, sustained by labor market gains and upbeat consumer sentiment. Economic activity in the euro area likewise continues to gain traction, with firm rates of growth seen in the core economies.

By contrast, economic activity in Asia and other emerging markets have turned more subdued. The recovery in Japan is still modest, while China’s economy is weighed down by the downturn in the real estate sector. At the same time, the global inflation environment remains benign with the soft outlook for prices of international commodities, including oil.

4. Domestic financial market conditions were favorable. BSP said the continued manageable inflation environment and favorable domestic growth outlook supported market sentiment during the quarter.

“Optimism was also supported by other central banks’ decision to ease monetary policy settings during the quarter to support domestic economic activity and guard against downside risks to inflation,” BSP said. However, uncertainty surrounding the timing of the expected increase in US interest rates as well as the resolution of the Greek debt crisis tempered market sentiment.

But domestic financial markets remained buoyant owing largely to investor confidence in the country’s macroeconomic fundamentals and appetite for domestic equities and government securities stayed healthy, while spreads on the country’s sovereign debt instruments decreased.

“The Philippine banking system also continued to be sound and resilient as indicated by various metrics for capitalization as well as asset growth and quality,” BSP said.

Domestic economic activity continues to expand at a solid pace. “Domestic demand remains firm, supported by ample liquidity and sustained credit growth. Planned increases in government spending should also provide a lift to economic activity,” BSP noted. (READ: Why can't government spend more?)

5. The BSP maintained its policy settings during the quarter. The Monetary Board decided to maintain the BSP’s key policy interest rates at 4% for the overnight borrowing or reverse repurchase (RRP) facility, 6% for the overnight lending or repurchase (RP) facility, and the accompanying rates for term RRPs, RPs, and the Special Deposit Account (SDA) or fixed-term deposits facility. The reserve requirement ratios were left unchanged as well.

Overall, BSP said monetary policy normalization in advanced economies, particularly in the US, and uncertainty due to the Greek debt crisis with its implications on the euro area economy, could be important considerations for the inflation outlook in the coming quarters. This is to the extent that they influence inflation expectations and market sentiment on the domestic front.

“Going forward, the BSP will continue to monitor domestic and external developments to ensure that the monetary policy stance remains consistent with its price and financial stability objectives,” the central bank said. – Rappler.com