MANILA, September 23, 2005
 (STAR) By Donnabelle L. Gatdula - The Bangko Sentral ng Pilipinas (BSP) raised yesterday its key interest rates by 25 basis points, the second such move this year, to tame rising inflation driven by higher oil prices.

The increase in the BSPís overnight rates follows a similar quarter percentage point rise by the US Federal Reserve on Tuesday.

The BSPís overnight borrowing rate will now stand at 7.25 percent and the lending rate at 9.50 percent. The rates, which are set every four weeks, were raised by a similar amount from a 13-year low on April 7.

"It is important for the central bank to undertake monetary action now to protect its inflation targets and help avoid the need for drastic tightening measures later," BSP Deputy Governor Nestor Espenilla said yesterday.

President Arroyo is counting on low interest rates to spur spending and investment as high oil prices erode corporate earnings and householdsí disposable incomes. Accelerating inflation, caused in part by gains in oil costs, will likely result in another rate increase this year, said Jonathan Ravelas, a market strategist at Banco de Oro, a Manila-based lender.

"The central bank is trying to combat persistent inflationary pressures," Ravelas said. "This is a signal to the market that interest rates have bottomed out and we should expect more increases."

Supply-side inflation pressures, Espenilla said, are expected to build up over the policy horizon given the likelihood of continued high crude oil prices for foreseeable future.

"Such an outlook, not only increases the risk of second-round defects from supply shocks but also poses a threat to inflation expectations, as the public may begin to expect inflation to remain indefinitely at high levels," Espenilla said.

Inflation rose 7.2 percent year-on-year in August after 7.1 percent in July as oil prices continued to soar.

The August figure was higher than BSP forecast of 6.6 percent to 7.1 percent. For the first eight months of the year, inflation averaged 8.1 percent, well above the full-year target of five-six percent.

Inflation is gathering pace as refiners raise pump prices of gasoline and diesel to reflect the rising cost of their crude oil imports.

Given that the projected risks from cost-side pressures have intensified in recent weeks, Espenilla said the MB believes that it is important for the BSP to undertake action now to protect its inflation targets and help avoid need for drastic tightening measures later.

According to Espenilla, the MB also felt that the recent growth in e money supply may not necessarily be channeled into consumption and investment spending, given that growth in bank lending has remained moderate and aggregate demand is slowing down.

Furthermore, the BSP official said the MB noted that the trend of rising foreign interest rates due to monetary tightening by other central banks could lead to further declines in interest rate differentials.

Declining interest differentials, he said, may encourage investors to buy more dollar-denominated assets.

"Combined with excess liquidity in the financial system, a shift toward dollar assets could lead to volatility in the peso-dollar exchange rate, which in turn could raise inflation and inflation expectations," he said.

The MB, he said, will continue to closely monitor the evolving conditions for consumer prices, aggregate demand, domestic liquidity and other factors in order to determine the appropriate stance of monetary policy.

Chief News Editor: Sol Jose Vanzi

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