Long-term inflation expectations remain ‘anchored’ despite shocks

By Katherine K. Chan, Reporter

LONG-TERM INFLATION expectations remain anchored despite persistent price pressures driven by oil shocks stemming from the Middle East war, a study by the Bangko Sentral ng Pilipinas (BSP) Research Academy showed.

According to a discussion paper penned by BSP researchers, long-run inflation expectations are “relatively stable,” hovering between 3.5% and 4.5% or around the upper bound of the central bank’s target. 

“Although long-run expectations fell at the start of the sample, they have consistently stayed near the upper end of the BSP’s current inflation target of 2%-4%,” BSP researchers Joan Christine S. Allon-Pineda, Carl Francis F. Maliwat and Cymon Kayle Lubangco said in the report.

The researchers noted that the recent oil supply shocks driving long-term inflation expectations toward the upper limit of the BSP’s target was similar to the trend seen during the COVID-19 pandemic.

“In general, the stable contribution of long-run expectations to predicted inflation suggests that in the long-term forecasting horizon, inflation expectations are relatively anchored,” they added. 

Germany-based think tank Deutsche Bank Research earlier said inflation expectations may be unanchoring following BSP Governor Eli M. Remolona, Jr.’s move to open the door for an off-cycle rate hike before the Monetary Board’s June 18 meeting.

At its April 23 meeting, the Monetary Board began its new tightening cycle as it lifted the key policy rate by 25 basis points to 4.5% for the first time in over two years. 

The BSP said the decision came as monetary authorities sought to curb second-order price effects and ensure inflation expectations are anchored amid mounting risks from the ongoing energy crisis.

Since the war in Iran erupted in late February, inflation has moved past the BSP’s target, even missing most forecasts as oil price spikes spilled over to other key commodities faster than anticipated.

In April, the headline clip quickened to an over three-year high of 7.2% from 4.1% in March and 1.4% a year ago.

The BSP has repeatedly said that it is ready to take all necessary monetary policy actions to bring inflation back to their tolerance range, as their projections show that inflation could average 6.3% this year and 4.4% in 2027. 

“Overall, the BSP’s policy actions do not appear to be mechanical reactions to inflation alone, but rather responses to persistent or broad-based inflationary pressures, largely consistent with the standard principles of optimal monetary policy,” the researchers said. 

The study sought to analyze underlying inflation and monetary policy dynamics using the Hemisphere Neural Network (HNN) model through two frameworks.

Supply-driven inflationary pressures stemming from the Middle East war continue to challenge central banks’ monetary policy frameworks, the BSP researchers noted.

“The recent surge in inflation has drawn increased attention to how central banks monitor economic conditions and calibrate policy responses,” they said. “However, inflation is inherently a complex and multifaceted phenomenon, and sound policy decisions require a broad and integrated perspective on economic conditions.”

“The HNN offers a promising solution for disentangling underlying inflation and policy dynamics under the NKPC (New Keynesian Phillips Curve) and Taylor rule frameworks,” they added.

According to the researchers, inflation expectations captured through the HNN model reflected factors such as real activity, inflation expectations, oil commodity prices, nonfuel commodity prices, credit conditions, central bank balance sheet and international conditions.

The study also found that estimates were accurate relative to the BSP’s business and consumer expectations survey as well as the survey of private sector forecasts.

This means the same expectations may be used to show the short- to medium-term of businesses and external forecasters when existing survey data prove limited, the researchers said.

The BSP’s latest expectations survey for March showed businesses expect inflation to average 3.3% in the next 12 months, while households see inflation settling at 2.7% in the year-ahead.