Philippine financial markets reel from Middle East conflict in Q1

By Abigail Marie P. Yraola, Deputy Research Head

RISING OIL PRICES amid the Middle East conflict sent the Philippine financial markets into tailspin in the first quarter, leaving inflation and policy uncertainty clouding the horizon.

The bellwether Philippine Stock Exchange index closed at 5,948.94 at the end of January-to-March period. This was lower by 3.8% from 6,180.72 logged in the same period a year earlier.

Yields on government securities rose by 35.84 basis points (bps) on average on a yearly basis based on the PHP Bloomberg Valuation Service Reference Rates published on the Philippine Dealing System’s website.

Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics, said that the outbreak of war in the Middle East in the middle of the first quarter dominated the narrative, which affected the markets and the real economy.

He added that the spike in global oil prices and consequently local fuel prices has exerted renewed downward pressure on Philippine equities.

“The peso has come under immense pressure because of the likely deterioration of the trade deficit in a high oil-price environment,” Mr. Chanco said in an e-mail.

For Marco Antonio C. Agonia, an economist at the University of Asia and the Pacific, local financial markets saw some early green shoots during the period.

However, the lingering impacts of the corruption scandal and geopolitical headwinds eventually weighed down investor sentiment.

“These green shoots then withered away as the Middle East war ensued, with financial markets pricing in the domestic economy’s vulnerability to oil shocks,” he said in an e-mail.

He pointed out that gains made in the first two months of the year vanished amid sell-offs in equities, fixed income, and foreign exchange markets.

“Weakened confidence, higher inflation expectations, and a safe haven dollar likewise saw the peso tumble to record lows,” Mr. Agonia added.

PESO PLUNGE Meanwhile, data from the Bankers Association of the Philippines showed the peso closed at P60.748 to the dollar as of end-March, depreciating by 5.8% from a year earlier.

It was also down by 3.2% from P58.79 finish at the end of 2025.

In the first quarter alone, the peso logged 11 all-time lows against the greenback.

In January, the local unit logged three record lows amid brewing tensions between the United States and Iran.

But when the US and Israel launched an attack on Iran on Feb. 28, it sent the peso careening to nine all-time lows in March alone.

Between April and May, the peso continued to record fresh lows five more times as tensions in the Middle East escalated.

The Philippine peso saw its weakest finish against the dollar on May 18 when it plunged to P61.750. The local currency remained at this record low on May 19.

As of June 11, the local unit ended P61.35 to a dollar, weaking by 4.2% since the Dec. 29 close of P58.79.

ACCELERATING INFLATION
In March, inflation accelerated to a two-year high of 4.1%, up from 2.4% in February and 1.8% in March 2025.

The March reading marked the fastest pace of inflation in nearly two years, since July 2024’s 4.4%. This also breached the central bank’s target of 2-4%.

The rise in inflation was driven by faster price increases in fuel and electricity, as the conflict in the Middle East disrupted global oil trade.

“Market participants appear to be pricing in the likelihood of faster inflation from hereon, however, we also believe that investors are pricing in not just inflation but the increasing likelihood of slipping closer to a stagflation or recession scenario,” Metropolitan Bank & Trust Co. (Metrobank) Chief Economist Nicholas Antonio T. Mapa said in an e-mail.

Ruben Carlo O. Asuncion, chief economist at Union Bank of the Philippines, said that inflation quickening signals a broadening of price pressures beyond initial fuel shocks, including transport, food, and utilities.

“Financial markets are likely to respond by pricing in additional policy tightening,” he added.

In its HSBC Global Investment Research report, HSBC Senior ASEAN Economist Aris D. Dacanay warned that “stagflation has taken shape,” pointing to a slower economic growth, rising inflation and higher unemployment rates.

“The economic environment should get tougher moving forward,” Mr. Dacanay cautioned.

POLICY EFFORTS
Despite the economic growth reaching well below potential, Mr. Dacanay expects the central bank to tug the monetary reins strongly and raise policy rates by 150 bps to 6% by the end of the year.

The estimate, he said, is fundamental to consider real rates and recognize what is needed to re-anchor inflation expectations.

“Secondly, the principle of ‘who can best deal with what’ also matters when addressing the dual risk of stagflation,” Mr. Dacanay said, noting that growth has weakened due to a decline in public capital expenditures.

The easiest way to restore economic growth is to ensure that fiscal policy is back on track and policymakers can do this by fast-tracking infrastructure, he said.

Local financial markets saw economic challenges or crisis as the Middle East conflict triggered global energy shocks.

Due to this global energy crisis, the Bangko Sentral ng Pilipinas (BSP) said that they may implement monetary policy tightening to combat quickening inflation.

Additionally, BSP Governor Eli M. Remolona, Jr. said that it has room to tighten as fiscal spending is expected to support economic growth.

Analysts highlighted that the BSP should adopt a calibrated and gradual approach to rate hikes but also stressed that fiscal policy should shoulder the burden to support economic growth.

For Metrobank’s Mr. Mapa, economic growth engines in the country were losing momentum well before the corruption probe and the conflict in the Middle East.

“A consistent build-up in household debt, years of private sector underinvestment due to the BSP’s last rate hike cycle all contributed to the moderation in economic activity,” he said.

While the central bank will prioritize its price stability mandate, Mr. Agonia said that “the burden now lies on the fiscal side and in the National Government’s strategies to cushion further price impacts.”

For Mr. Chanco, the central bank’s approach to hike again in the next meeting (June) may be debatable as he “believes that would be rash for the BSP to respond to this largely supply-side driven price shock with rate hikes that will have no effect on the origin of the problem.”

He also explained that the economy’s persistent sluggishness is likely to minimize the risks of this supply-side price shock translating to more enduring demand-side price pressures.

Mr. Asuncion said that the central bank faces a delicate balancing act between controlling inflation and avoiding a deeper economic slowdown.

He said that the surge in inflation is driven by supply issues rather than excessive demand and this limits the effectiveness of aggressive interest rate hikes.

He added that rising inflation expectations and a weakening peso justify some tightening of policy.

“A calibrated approach is therefore warranted — favoring gradual, data-dependent rate hikes to anchor expectations while minimizing damage to growth.”

GROWTH DOWNGRADE & MARKET IMPACT
The first three months of the year saw the International Monetary Fund (IMF) has downgraded growth projections for the country due to its heavy reliance on oil imports amid the crisis in the Middle East.

The IMF cut the country’s 2026 gross domestic product growth forecast to 4.1% from 5.6% in January, citing weaker growth momentum in 2025 and the impact of the war in the Middle East, according to the latest World Economic Outlook.

At the same time, it expects 4.1% growth for the ASEAN-5 region, which includes Indonesia, Malaysia, the Philippines, Singapore and Thailand.

This decision to downgrade growth forecast reflects the significant drag from elevated oil prices and external vulnerabilities and consequently, this has implication for local financial markets, Mr. Asuncion said.

He explained that weaker growth expectations are negative for equities, as they imply softer corporate earnings and reduced investor sentiment, but it can be supportive for bonds by reinforcing expectations of limited policy tightening, although this is offset by inflation pressures.

“The peso is likely to remain under pressure due to a wider current account deficit driven by higher oil imports,” he said.

He added that the IMF’s recommendation to “stand pat” aims to maintain policy space while the BSP’s inclination toward tightening reflects near-term inflation risks.

“The optimal approach lies between these views: a cautious tightening bias in the near term, coupled with flexibility to pivot if growth weakens further,” Mr. Asuncion said.

Given this, markets are likely to interpret this as a signal of policy uncertainty, which could lead to continued volatility.

Mr. Agonia said that weaker economic growth will likely put financial markets on edge and risk-off.

“Markets will likely pay more attention to the BSP’s hawkish stance, considering that the Philippines remains one of the most vulnerable countries to this oil crisis in Asia.”

MARKET DRIVERS TO CONSIDER
For Mr. Agonia, market participants should look out for further impacts of the Middle East crisis in the domestic economy.

“Even if peace in the region breaks out soon, the country may see prolonged above-target inflation as second round effects take hold,” he said noting that market volatility could also set in, as participants continuously digest information flows coming out of the Middle East.

He added that key drivers that hampered the financial markets in the first quarter will persist in the coming months.

Mr. Chanco said that the duration of the Middle East war may be critical, suggesting that even if it finds resolution during this quarter, market rebound may be short-lived.

“Fundamentally, the Philippine economy remains weak and was weak before the war started,” he said.

Mr. Asuncion said that external developments include the trajectory of oil prices and the evolution of the Middle East conflict will remain the dominant drivers of global inflation and risk sentiment.

“While some projections suggest that supply disruptions may ease, uncertainty remains high and volatility could persist.”

Locally, he said that the path of inflation, specifically core inflation, will be critical in shaping monetary policy.

“Investors should also track BSP policy signals, fiscal spending implementation, and the recovery of investor confidence following governance issues,” he said.

FIXED-INCOME MARKET
Mr. Agonia: Yields may continue rising as inflation expectations adjust upwards. Furthermore, the hawkish BSP stance will continue pushing yields up. Yield curve steepening could set in as bond market participants shorten duration and medium-term inflation expectations raise long-end yields. Government securities’ auctions may continue seeing lackluster appetite.

Mr. Asuncion: The fixed-income market is poised for continued volatility with an upward bias in yields, particularly at the front end of the curve. Persistently high inflation is expected to keep policy tightening expectations in play, driving short-term yields higher. Meanwhile, the long end may be more anchored as growth concerns intensify, creating scope for a flattening bias initially, followed by gradual steepening if economic conditions soften further. External factors, including global yield movements and risk sentiment, will add to volatility, while a wider fiscal and current account position may introduce additional supply pressures. Overall, bond markets will remain highly data-dependent, with inflation prints and central bank signals as the primary drivers.

Mr. Mapa: Yields likely pressured higher by scenario of faster inflation and BSP rate hikes.

EQUITIES MARKET
Mr. Agonia: Risk-off with some volatility for now. Local stocks are grappling with a higher inflation scenario and a hawkish BSP, which will especially weigh on cyclical counters. Blue chips have also signaled more conservative forwards earnings guidance, which will keep investors cautious. Crucially, the market needs to see a definite step towards peace in the Middle East to facilitate a sustained rally. So far, movements have been lacking conviction and are largely technical. The pushing and pulling among belligerent states in the Middle East conflict will continue driving volatility in commodities and financial markets until a solid peace deal is achieved.

Mr. Asuncion: The equities market is expected to trade range-bound with a mild downside bias in Q2 2026, as elevated inflation and slowing growth continue to weigh on sentiment. Higher energy costs are likely to compress corporate margins and dampen consumption, while lingering uncertainty around fiscal execution and confidence recovery limits earnings visibility. Global risk aversion may also constrain foreign inflows and keep valuations under pressure. That said, selective opportunities remain in defensive sectors such as utilities and consumer staples, as well as in energy-linked names that benefit from elevated commodity prices. Overall, the market is likely to move sideways with bouts of volatility, with any sustained upside dependent on clearer signs of inflation peaking and improved policy visibility.

Mr. Mapa: Equities may be challenged by slow inflation scenario (slow growth and high inflation).

FOREIGN EXCHANGE MARKET
Mr. Agonia: Peso dollar could trend sideways with some depreciation bias. The forex rate is still under siege from elevated oil prices, and volatility in the latter could raise risk premia for the former. BSP rate hikes may support the peso dollar rate, but a hawkish Fed stance may soften any gains against the greenback. BSP has shown willingness to intervene, but a newfound slide in reserve holdings may make BSP less aggressive in forex intervention. 

Mr. Asuncion: The peso is likely to maintain a depreciation bias in Q2, reflecting structural pressures from elevated oil import costs and a widening current account deficit. High inflation and fragile risk sentiment may further weigh on the currency, although potential rate hikes could provide partial support by narrowing interest rate differentials. Central bank intervention is expected to smooth excessive volatility but not reverse the broader trend. As such, the peso is likely to weaken gradually within a manageable range, with movements largely dictated by oil price dynamics, external conditions, and the pace of policy response.

Mr. Mapa: Currency to remain on the backfoot as current account dynamics point to a wider deficit.