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According to Felipe Medalla, governor of the Bangko Sentral ng Pilipinas (BSP), maintaining a sufficient interest rate divergence between the Philippines and the US will help to reduce market uncertainty.

In an interview with CNBC on Friday, Medalla claimed that the current 1.25 percent difference between the BSP’s overnight reverse repurchase (RRP) rate and the Federal Reserve’s key rate is what “the market seems to think is its appropriate differential between our policy rate and the US policy rate.”

After the policy-making Monetary Board (MB) on Thursday kept the central bank’s rates unchanged, Medalla responded to a question on how long the BSP can retain its key rates by stating that “if inflation were purely a domestic issue, the pause will probably be no longer than two or three meetings.”

“But we’ll have to be very vigilant about the extent to which a small differential between our policy rate and the Fed’s could cause significant weakening of the peso, which may become the new anchor of inflationary expectations,” the official said.

Therefore, Medalla stated that the BSP will undoubtedly consider any international developments that will impact the domestic rate of price increases and cause second-round repercussions in determining its policy position.

It is prudent to take a break, but at the same time, raising rates would be counterproductive because, as was already mentioned, the month-over-month inflation rate is already relatively low. It’s a little bit negative,” he remarked.

The BSP did not follow the Fed’s action, a rate hike earlier this month, for the first time after noting the deceleration in the domestic inflation rate. The MB’s decision to pause the central bank’s rate hiking cycle, which started in May 2022 and has resulted in the 425 basis point increase in the key rates, was made on Thursday.

Domestic price growth has moderated after reaching a 14-year high of 8.7 percent in January of last year and reported a 6.6 percent annual rate in April.

In the last quarter of the year, monetary officials predict that monthly inflation will revert to the government’s 2-4 percent goal range.

Medalla thinks the Philippines should have an interest rate divergence of 75 basis points from the US if its foreign reserves are already close to USD 120 billion.

As of late April, the nation’s foreign reserves were USD101.51 billion, which is greater than the international standard of three to four months and is equal to almost 7.6 months’ worth of imports and service payments.

“So, it’s the market that determines what differential will result in a peso that is not depreciating too much, a more stable peso,” he explained, adding that he believes the market prefers a differential rate of between 100 and 125 basis points.

He claimed that “the next dialogue with the market” would take place if efforts were made to persuade consumers that they could live with a smaller market.

But as things are, he continued, “if we ignore the market in this regard, we will be a little too reckless.”

The peso is trading at a 55–56 level against the dollar, which is an improvement after repeatedly falling to a record-low 59.00 level in September and October 2022.

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