With CPI at 14-Year Highs, the BSP Hikes Policy Rates to 14-Year Highs! The Switch to a Policy Hawk!

   

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible…There is danger in the exuberant feeling of ever growing power which the advance of the physical sciences has engendered and which tempts man to try, "dizzy with success", to use a characteristic phrase of early communism, to subject not only our natural but also our human environment to the control of a human will. The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society - a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals—Frederick August Hayek 

 

In this issue 

 

With CPI at 14-Year Highs, the BSP Hikes Policy Rates to 14-Year Highs! The Switch to a Policy Hawk! 

I. With CPI at 14-Year Highs, the BSP Hikes Policy Rates to 14-Year Highs! The BSP’s Switch from a "Dovish" to a "Hawkish" Stance! 

II. The BSP is No ex-Fed Chairman Paul Volcker, The Reversal of Structural Forces of Disinflation 

III. Does the BSP Know How its Policy Asymmetry will Impact the Economy? 

IV. BSP Rates and the CPI at 2008 Levels: A Mental Exercise Comparing the Economy Today and 2008 

V. Government, Banks, and Real Estate Sectors as Major Beneficiaries of BSP Policies 

 

With CPI at 14-Year Highs, the BSP Hikes Policy Rates to 14-Year Highs! The Switch to a Policy Hawk! 

 

Surprised by the 14-year CPI, last week, the BSP "matched" its rate hike to a 14-year high and signaled a shift to a policy "hawk."  Is the BSP aware of the ramifications of their actions? 

I. With CPI at 14-Year Highs, the BSP Hikes Policy Rates to 14-Year Highs! The BSP’s Switch from a "Dovish" to a "Hawkish" Stance! 

Inquirer.net, February 18: The key policy rate of the Bangko Sentral ng Pilipinas (BSP) is expected to rise by another 0.75 percentage point (ppt) in the coming months to peak at 6.75 percent after the Monetary Board raised its forecast for the average inflation in 2023. The BSP now sees inflation this year to clock at 6.1 percent instead of the 4.3-percent forecast that was made in November 2022. Along with the 0.5-ppt rate hike from 5.5 percent to 6 percent that was announced on Feb. 16, the higher forecast was attributed to upward pressures coming from rising food prices, transport fares and wages. MB chair and BSP Governor Felipe Medalla said in a Feb. 17 interview with CNBC that raising the policy rate in two or three more upcoming meetings this year was “difficult to rule out.” “Want to send a strong signal that inflation remains a problem,” Medalla said. We want year-on-year inflation (meaning, the average inflation in a given month) to be below 4 percent by yearend.” 

After being jolted by the January 2023 CPI, the BSP suddenly shifted from a "dovish" to a "hawkish" stance.  

 

As previously mentioned, this volte-face represented a communication and expectation error.   

 

That is to say, if they raise rates by a mere 25 bps, then this validates our conjecture.  If they should raise rates by 50 bps, which means that the unexpected CPI rates forced them, it shows how communication errors could backfire. (Prudent Investor, 2023)

 

Moreover, aside from the constant mispredictions, this event reinforces the view that the BSP has been making it up as they go along.  Or they improvise policies for ad hoc short-term objectives.   

 

The principal thing is the BSP seems unaware of the feedback loops from their actions, which also translates to their seeming obliviousness to the long-term consequences of their policies.   

 

As such, their "knowledge problem" translated into behavior-altering policies only magnifies systemic risks. 

 

Figure 1 

With the statistical inflation or the CPI at 14-year or 2008 highs, the BSP "matched" its monetary policy by raising official rates to the same 14-year or 2008 watermark. (Figure 1, upper chart) 

 

It is unclear whether the BSP observes a standard that pairs its policy rate level with a corresponding CPI range or if the present action merely represents a coincidence.   

 

The BSP is aware of the Taylor rule—a formula that ties central bank policies to inflation and economic growth rate—though according to this study, the rule represents "one of its [BSP's] guide posts in policy formulation, it does not blindly adhere to this policy rule." (Dacio & Cruz, 2012) 

 

And if the BSP maintains such a standard, what have been the criteria that led to the choice of the headline over the Core CPI?  January's Core CPI was at a 22-year high. (Figure 1, lower graph) 

 

II. The BSP is No ex-Fed Chairman Paul Volcker, The Reversal of Structural Forces of Disinflation 

 

The BSP is certainly no Paul Volcker.  The ex-Chairman of the US Federal Reserve, the late Paul Volcker, broke the back of inflation by shifting their target from interest rates to the money supply. (bold mine) 

 

Volcker, in office only two months, took the radical step of switching Fed policy from targeting interest rates to targeting the money supply. The days of "easy credit" turned into the days of "very expensive credit." The prime lending rate exceeded 21 percent. Unemployment reached double digits in some months. The dollar depreciated significantly in world foreign exchange markets. Volcker's tough medicine led to not one, but two, recessions before prices finally stabilized. (Poole, 2005) 

 

But that was only the visible aspect from the monetary standpoint. 

 

Other forces joined hands to bottle up or rein inflation. 

 

The international trend of increased globalization bolstered by domestic liberalization expanded economic cooperation and coordination, which helped lubricate supply chains that enhanced productivity and raised investments. 

 

And this partially explains the reversal of the age of inflation to the age of disinflation. 

 

But the current environment operates from a diametrical dynamic.  

 

Mounting global tensions, insularity, and fragmentation lead to disruption of the division of labor and economic dis-coordination, thus, magnifying various risks of a debt-to-the-eyeballs environment. 

 

As Rabobank’s Mr. Every risibly narrates: [bold and italics original] 

 

Nonetheless, current risks are of a close encounter with inflation of the third kind: not the cyclical, transitory, supply-driven kind we can ignore; nor the cyclical, demand-driven kind we easily fought with monetary or fiscal policy; but rather the nasty structural mixture of supply and demand driven inflation that comes with unstable geopolitics, the weaponization of commodities and supply chains, and a shift back to national security, industrial policy, and protectionism. Which is where UFOs and Top Gun antics come in. (Every, 2023) 

 

That is to say, increasing centralization or politicization of the production and distribution of resources, finances, economic allocation, and expanding reliance on central banks for financing should lead to an era of "sticky" elevated inflation and a heightened risk environment. 

 

III. Does the BSP Know How its Policy Asymmetry will Impact the Economy?

 

Figure 2 

 

Returning to the BSP. 

 

Despite the rate hikes, the BSP's currency issuance this January was just off the record high attained in December 2022.  While its growth rates have been softening, that's partly due to the high base effects.  (Figure 2, upper chart)  

 

The return of deposits that increased BSP liabilities to the central government in January 2023 also affected currency issuance to the downside.  

 

At any rate, policy asymmetries such as interest rate caps on credit cards, the various bank relief measures, and liquidity operations with the banking system have partly offset the impact of rate hikes.   

 

As a result, unlike in 2018, bank credit continues to expand even as the bond markets have signaled a tightening of liquidity over time.  The flattening spread between the BVAL 10-year rates and the BSP's ON RRP indicates such tightening or the upcoming countercyclical "disinflation." (Figure 2, lowest graph) 

 

It's why the BSP boasts that it can hike rates by more. 

 

But does the BSP know the longer-term impact of such asymmetric policy on the financial industry and the economy? 

 

IV. BSP Rates and the CPI at 2008 Levels: A Mental Exercise Comparing the Economy Today and 2008 

 

To what extent is the BSP aware of the vital differences between the economy and financial system in 2008 and today and the possible overlapping and reflexive effects of their present policies? 

 

Let us do a back-of-the-envelope exercise comparing the economy in 2008 and today.  

 

Figure 3 

 

There seems little understanding that the economic structure has metamorphosized towards increasing dependence on credit and money supply as the engine of growth. 

 

Let us count the ways: 

 

M1-to-GDP has more than doubled from 2008.  M1 now represents a third of the GDP.  

 

Meanwhile, M2-, M3-, and domestic claims-to-GDP now account for over 70% of the GDP, growing by over 60% from 2008. (Figure 3 topmost window) 

 

Plainly stated, with the current level of rates, the financial system and the economy have increasingly become vulnerable to duration or interest rate risks. 

 

There's more.  

 

Domestic claims of the BSP have posted an 8.76% CAGR over the last 14 years, while net claims on the central government have a CAGR of 12.52%.  (Figure 3, middle chart) 

 

From another angle, the BSP's assets have tripled through October 2022 for a CAGR of 8.5%. (Figure 3 lowest graph) 

 

In the meantime, the credit portfolio of the universal and commercial bank has exploded: it has grown fivefold for a 13.04% CAGR!  

 

On the other hand, public debt has tripled over the last 14 years to post a CAGR of 8.61%. 

 

Figure 4  

 

Combined, systemic leverage (universal and commercial bank plus public debt) has also more than tripled for a CAGR of 10.25%.   The % share of systemic leverage has swelled from 76.12% of the current GDP in 2008 to 109% of the NGDP in 2022. (Figure 4, upper chart) 

 

How does this compare with the GDP? 

 

Real GDP has a CAGR of 4.86%, while the current price GDP has a CAGR of 7.45%.   

 

In the meantime, the CPI has a CAGR of 3.32%. 

 

On a per capita basis, real GDP has a CAGR of 3.26%, while household consumption GDP has a CAGR of 3.04%. (Figure 4, lowest window) 

 

The short story, BSP activities have fueled credit and money expansion that grew faster than the GDP.   

 

In this context, the economic and financial system has also become increasingly driven by the policies and operations of the BSP. 

 

Or, the larger the role of the BSP, the greater the centralization of the economy through the financial institutions. 

 

V. Government, Banks, and Real Estate Sectors as Major Beneficiaries of BSP Policies 

 

But there is a more crucial aspect: The cause and effect.  Credit and money expansion, as noted above, have become the primary engines of the nation's development model.  

 

Figure 5 

The GDP showcases the areas that have benefited most from the present policy backdrop.   

 

First, from the expenditure side, public spending GDP has grown faster and taken a larger share of the GDP pie at the expense of household consumption.   

 

The public spending share of the GDP pie has a CAGR of 2.8%, while household consumption slipped by .212%, compounded annually. (Figure 5, topmost chart) 

 

Next, from the industry side, accommodation (hotel and restaurants), financials, professional services, and construction registered the fastest CAGRs of 5.08%, 3.5%, 3.2%, and 2.43%, respectively.  (Figure 5, middle window) 

 

Base effects may have been a factor in the substantial growth of the accommodation sector.  

 

Among the primary sectors, the financials clocked the fastest CAGR attaining a 10% share in 2022.  

 

In the meantime, manufacturing and real estate posted negative CAGRs of -.8% and 1.06% in their respective shares of the GDP.  The trade sector had a CAGR of 1.95%.  Their corresponding share of the GDP in 2022 was 18.7%, 5.6%, and 18.6%. 

 

Imagine, the share of professional services (scientific, legal, advertising, management consulting, architecture, and photography) to the national income has topped the real estate sector!  

 

Real estate marketing and promotion have almost been ubiquitous! Yet, where have ya' heard of this? 

 

Yet, while real estate's share of the GDP shrank, its share of banking loans has grown from 14.83% in 2008 to 20% in 2022 for a CAGR of 2.16%! (Figure 5, lowest graph) 

 

That folks represent a conspicuous sign of malinvestment and a red flag for financial risks. 

 

And again, the government and the financial institutions were the primary beneficiaries, while real estate got most from the banks. 

 

We have used for this mental exercise the economic and financial conditions of 2008 for comparison with the present, which may be the basis for the BSP's model to arrive at their decision.   

 

The economic and financial gap would have been wider had the 22-year high of the Core CPI been the basis for this analysis. 

 

We ponder if the BSP has knowledge of the possible contagion and other related risks once something snaps or breaks in the system and the necessary tools for damage control.  

 

From the looks of how they have managed the CPI that prospect seems not optimistic.  

 

Finally, should credit take up significantly slow, it should drag the economy down, which should likewise pull lower the CPI.   

 

But given the path dependency or policy bias of the monetary authorities to protect the free lunch of public spending and public debt, their response would be abruptly cut rates and inject enormous amounts of liquidity.  

 

The 2020 episode represents a template for their rescue measures. It would be repeated once the opportunity arrives.  

 

Unknowingly for them, these actions should combust the third wave of the inflation spike that reinforces the age of inflation/stagflation! 

 

_____ 

References 

 

Prudent Investor, Stagflation Ahoy! Defying the Consensus, Headline and Core CPI Hits Decade Highs! BSP QE 2.0 as a Principal Driver! February 13, 2023 blogger, substack 

 

Dacio, Jasmin E. & Cruz, Christopher John F., Tenets of Effective Monetary Policy in the Philippines, p.25, 2012, Bangko Sentral ng Pilipinas  

 

Poole, William, President's Message: Volcker's Handling of the Great Inflation Taught Us Much 

January 01, 2005 Federal Reserve of St. Louis https://www.stlouisfed.org/ 

 

Every, Michael Unidentified Flying Inflation, Zerohedge, February 13, 2023