- The Philippines central bank cut rates by 25bps in its December meeting, bringing the policy rate to 4.50% from 4.75% previously. This was expected by ourselves and virtually all economists as surveyed in the BBG consensus.
- More importantly, the BSP turned less dovish in its forward guidance by signalling that the end of monetary easing is likely near, with the path more data dependent from here.
- Moving forward, we are forecasting one more rate cut by the BSP likely in the next meeting in 2026 before an extended pause, and as such bringing the policy rate to 4.25%.
- Our base case is that government spending should pick up next year, but with growth remaining below trend with a still negative output gap. Past episodes of corruption issues in the Philippines such as the 2013 Priority Development Assistance Fund (PDAF) suggests government spending should start to improve after around 6 months, but importantly full normalisation will likely only come more than a year later.
- We as such still see the risks tilted towards more and earlier cuts by the BSP given below trend growth and a still negative output gap, even as we agree directionally with the BSP’s assumption of some economic improvement in 2026.
- From an FX perspective, USD/PHP saw some retracement given the less dovish tone by the BSP. We are forecasting USD/PHP to recover modestly to the 58 levels in 1H2026 as the Dollar weakens, but we see this FX move as being shallow given a relatively dovish BSP.
Details:
Some takeaways from the BSP December policy meeting:
- We think that the BSP’s less dovish tone in the December meeting is BSP’s attempt to make sure that market expectations do not run too far ahead in the way of further rate cut expectations for 2026.
- For context, in the last meeting the BSP Governor highlighted the possibility that the neutral rate could now perhaps be as low as 4%, and relative to previous in-house estimates of around 5% (see BSP surprise rate cut with dovish tone).
- During this meeting, the BSP Governor however said that the central bank has varying estimates of the neutral rate (or “goldilocks rate” as mentioned in the press conference), and the central bank is trying to sort out the different factors and models. For now, they are not relying so much on the neutral rate and focus more on using traditional measures of output gap and with that inflation and growth projections, together with judgement ultimately by the Monetary Board.
- In addition, the BSP also raised its inflation forecasts slightly to 3.2% for 2026 and 3% for 2027, from 3.1% and 2.8% previously, on the back of some changes in assumptions on global food and oil prices coupled with possible supply side shocks from typhoons for instance.
- Lastly, the BSP made it clear that they do not target the exchange rate directly, and as such even if USD/PHP goes to 60 it does not change the way it manages monetary policy.
- The BSP Governor however said that the exchange rate tends to matter much more when: 1) there is sharp weakness in FX, and 2) this is combined with meaningful increases in global commodity prices such as oil or food.
- As such, the BSP’s FX intervention is done to make sure that there are no one-side USD/PHP moves, and also done in a strategic manner.
Our expectations moving forward:
- Overall, we expect USD/PHP to recover modestly to the 58 levels in 1H26 as government spending improves and capital inflows pick up on the back of a recovery in growth and FDI inflows. Nonetheless, we see this FX move as being shallow given a still dovish BSP, with the current account deficit unlikely to narrow significantly despite softer domestic demand. Risks may come from a meaningful slowdown in reform momentum or a further delay in government spending, but this is not our base case.
- We forecast the Philippines’ growth to improve slightly above 5% in 2026, as government spending picks up post the pullback from the flood control projects corruption cases. One key driver of the divergence between a weaker Dollar and underperformance in PHP has been a sharp slowdown in government spending including in public infrastructure, and the resultant impact this has had on capital inflows such as into the equity markets. This has also translated into the GDP numbers with growth moderating sharply to around 4%yoy from 5.5%yoy, driven by much weaker domestic demand with both fixed investment and consumption spending softening. Past experience from episodes of corruption cases such as the 2013 Priority Development Assistance Fund (PDAF) shows that government spending could start to improve after around 6 months, but importantly only fully normalise more than a year later. This is in a sense our implicit base case, and is reflected in our expectation for government spending to pick up next year, but with growth remaining below trend with a still negative output gap.
- We expect the BSP to remain dovish and forecast the central bank to cut rates to 4.25% in 2026, with risks tilted towards more and earlier rate cuts. Softer growth, uncertain fiscal impulse, and continued negative output gap we forecast in the Philippines implies the BSP is likely to remain dovish moving forward. We have another 50bps of rate cuts in our forecast profile, and we see the risk tilted towards more cuts. The lagged impact of a negative output gap is likely to weigh on core inflation, while low global oil and rice prices are also likely to cap any upside pressures on headline inflation more broadly. There are some risks arising from the government’s move to ban rice imports into end-2025 coupled with a new formula for rice import tariffs for 2026, but overall we think low global rice prices and still decent domestic rice inventories should cap upside pressures for now.
- Positives include the strong momentum in renewable energy sector, robust pipelines of private investment commitments, support for domestic demand from the lagged impact of lower inflation and rates, coupled with some increased tariff exemptions for the Philippines’ agriculture exports. While the infrastructure graft cases are taking up mindshare right now, it is important to remind ourselves of the existing positives. These include the very strong momentum in renewable energy sector investments, and we see this being translated into a surge in FDI approvals as well. From a balance of payments perspective, this should also imply that FDI should likely pickup in 1H2026. In addition, the pipeline of private investment commitments in infrastructure sector remains strong, and for now the spillover from the corruption cases on general investment commitments seems to be negligible. With inflation likely remaining low and below the mid-point of the BSP’s inflation target in 2026, this should help support domestic demand and in particular consumption spending given the lagged impact of lower inflation and rates. Last but not least on the external front, the Trump administration has exempted several agriculture products from reciprocal tariffs, including coconuts and its products, bananas, beef, coffee, tomatoes, among others. Our analysis suggests that these tariffs make up around 6% of the Philippines’ exports to the US, and should as such be helpful.