Angelo Taningco
Economist, Treasury Group
Global Developments & Outlook
Global growth to stay robust, desynchronizing on mounting risks. Q2 GDP growth accelerates in US, dips in China. Growth moderation expected for euro area and Japan. The International Monetary Fund’s (IMF) latest projections reveal no change to their global growth outlook in 2018 and 2019, expecting the world economy to expand 3.9% for both years. It did not alter its United States (US) growth forecasts of 2.9% for this year and 2.7% for next year. Nor did it change its growth forecasts for China, which is still foreseen to settle at 6.9% this year and 6.6% next year. Note though that the two-largest economies in the world exhibited mixed growth trends during the second quarter (Q2) of the year.
US GDP growth jumped to an annual rate of 4.1% in Q2, almost doubled the revised first quarter (Q1) revised figure of 2.2%. This is the strongest growth since 2014, but is a slight miss in comparison to the market’s median forecast of 4.2%. The growth improvement stemmed from accelerations in personal consumption expenditures (PCE), government spending, and net exports that more than offset the reduction in private inventory investment and slower growth in nonresidential fixed investment. However, we expect GDP growth to cool down starting in the third-quarter (Q3) amid a high base and increasing headwinds to growth, and to settle close to 3% for the full year.
In China, the GDP growth rate slid to 6.7% yoy in Q2 from 6.8% in Q1, though consistent with market expectations. This brought first half (H1) GDP growth at 6.8%, a notch lower than IMF’s forecast for the year. We anticipate China’s GDP growth to hover within the 6.5% and 7.0% range in the second half (H2) of the year.
IMF revised down its 2018 growth forecasts for the euro area—which recorded slower-than-expected Q2 GDP growth of 2.1% (market forecast: 2.2%) from 2.5% in Q1—and Japan by 0.2 percentage point (pp) apiece to 2.2% and 1.0%, respectively.
Inflation rises in US, little changed in euro area, Japan, China. June inflation of US nudged higher but while that of euro area was also little changed. US consumer price index (CPI) and PCE inflation rates have already touched the 2% target of the Federal Open Market Committee (FOMC) in recent months. CPI year-on-year (yoy) headline and core inflation rates edged up 0.1 percentage point (pp) in June from previous month to 2.9% and 2.3%, respectively. Meanwhile, PCE inflation is expected to be steady in June compared to May. Euro area consumer price inflation stood at 2.0% (headline) and 1.0% (core) in June, little changed from previous month.
The two-largest Asian economies have continued to register inflation rates that are below their government target. China’s CPI inflation edged up to 1.9% yoy in June from 1.8% in May, similar to market expectations but way below the government’s 3% objective. In Japan, headline CPI inflation was unexpectedly flat at 0.7% yoy in June (market forecast: 0.8%) while core CPI inflation unsurprisingly nudged higher to 0.8% yoy in June from 0.7% in May; yet, this remains way below the Bank of Japan’s (BOJ) 2% target.
FOMC to hold rates in 31 July – 1 Aug meeting. ECB, BOJ kept key rates unchanged. The Federal Open Market Committee (FOMC) is expected to decide during its 31 July – 1 meeting to hold steady the target range of the federal funds rate at 1.75% – 2.00%. Minutes from the FOMC’s 12-13 June meeting has reaffirmed the gradual rate hike path given strong economic activity and labor market as well as rising inflation. Against this backdrop, we expect two more US rate hikes at 25bps each this year, the next one in September and the last for the year in December. However, the minutes also reveal FOMC’s concerns on increasing uncertainty and risks arising from the global trade war tensions.
The European Central Bank’s (ECB) Governing Council decided on 26 July to keep key interest rates unchanged, as expected. It provided forward guidance on its key rates, anticipating these to remain at current levels “at least through the summer of 2019”. It also decided to keep its asset purchase program at its current monthly pace until Q3, after which it will be reduced to half in Q4 and to end starting next year.
The Bank of Japan (BOJ) Policy Board decided on 31 July to keep key rates unchanged, thereby maintaining the BOJ’s yield curve control. It provided forward guidance on rates by stating that it aims to keep these at current levels for an “extended period of time.” It, however, added new language to its intent of keeping the 10-year Japanese Government Bond (JGB) yield at about zero percent by now allowing it to “move upward or downward to some extent.” It likewise altered its statement on the BOJ’s exchange-traded funds (ETF) purchases, to shift it away from Nikkei 225 and towards the Topix index, but maintaining its asset purchases at the current size.
Trade war escalates for US-China, eases for US-EU. US-China trade war escalated in July, triggered by US imposition of 25% tariffs on $34 billion (b) of Chinese imports on 6 July. China responded immediately with retaliatory tariffs on $34b of mostly US agro-based goods. On 10 July, US Trade Representative Robert Lighthizer said that US may impose 10% tariff on $200b of Chinese imports after the end of its consultations on 30 August. China responded that it was “shocked” by the US tariff announcement, describing it as “totally unacceptable” and has vowed to “retaliate”. In a 15 July interview, US president Donald Trump labeled China a “foe economically”. On 20 July, Trump said he’s “ready to go” all out with tariffs on $500b worth of Chinese imports, adding that US is “being taken advantage” by China on trade.
In contrast, US-EU trade war fears have abated following the 25 July meeting of Trump and European Commission (EC) president Jean-Claude Juncker. Both leaders have agreed to suspend new tariffs while undergoing bilateral trade negotiations. They also promised to lower industrial tariffs (except auto tariffs) and increase US exports of soybeans and liquefied natural gas to EU.
UST yield curve bear flatten. US Treasury (UST) yields rose in July with the curve “bear flattening”. The 2yr-10yr yield spread narrowed to its lowest level in 11 years at 24bps on 17 July before drifting closer towards 30bps by the end of the month. Market expectations of additional rate hikes by the FOMC alongside dim US long-term growth prospects amid trade war and fiscal concerns have reduced the slope of the curve.
The UST 10-year yield recorded a steep increase in the second half of July in reaction to market speculation that the BOJ may tweak its yield curve control to allow it to steepen. The 10-year yield of Japanese Government Bond (JGB) likewise responded with a spike during the same period.
EM depreciation persist, equity market pressures stabilized amid drop in oil prices. Emerging markets (EMs) have incurred currency depreciations overall but equity market pressures appear to have stabilized somewhat amid global trade war tensions and idiosyncratic factors.
MSCI’s EM currency index reached its lowest point for the year on 19 July before climbing but falling short from its end-Jun level. The worst-performing EM currency for the month is the Turkish lira following a Fitch ratings downgrade. The Chinese yuan also had depreciated relatively strongly following the central bank’s action to weaken the yuan fixing by 0.9% on 18 July. Meanwhile, MSCI’s EM index was up for the month, illustrating a rebound in the region’s equity markets. Similarly, equity markets in advanced economies (US, euro area, Japan) improved somewhat in July compared to June.
Global oil prices have stayed elevated during early July but have started to do down and stabilized around $70/bbl for the WTI and $75/bbl for the Brent.
Philippine Developments & Outlook
Q2 GDP growth forecast at 6.7%, manufacturing sector robust in May. We estimate Q2 GDP growth at 6.7% yoy. We assess growth to be robust on the back of potentially strong activity in construction, manufacturing, finance, real estate, and retail trade. Manufacturing output posted double-digit growth for the fifth-straight month in May, reinforcing our positive growth view. On the demand-side, we think household spending, business investment, and government disbursements were instrumental in propelling Q2 growth and more than offset the negative contribution of trade. We also believe growth was boosted by healthy output activity reinforced by construction, manufacturing, finance, real estate, and retail trade that outweighed the sluggishness of the agriculture sector.
Inflation climbs to record-high in June, Q2, to accelerate further in July. Headline CPI inflation jumped to a new record-high 5.2% yoy in June, eclipsing all forecasts for the month provided by the market and government. This is the fourth-straight month that headline inflation breached the upper end of the government’s inflation target range. Similarly, core CPI inflation surged to its highest level of 4.3% in June from 3.6% in May; the first time that it eclipsed the upper end of the government’s target range. In Q2, headline and core inflation averaged 4.8% and 3.8% yoy, respectively, both also at record-high levels.
We forecast headline inflation for the month of July to be at 5.7% yoy. This is within but close to the upper end of the Bangko Sentral ng Pilipinas (BSP) inflation forecast range of 5.1% – 5.8% for the month. Our view of a further acceleration in yoy inflation is premised on sharper food price inflation on supply disruptions amid heavy rainfall and flooding; elevated import costs; and hikes in petroleum, transport fares, and minimum wages.
“Strong” monetary policy adjustment expected in Aug, RRR cuts to resume in 2019. We now expect the BSP’s Monetary Board to raise the policy rate (overnight RRP rate) by 50bps to 4.00% in its next monetary policy meeting scheduled on 9 Aug. This, we think, is consistent with BSP Governor Nestor Espenilla, Jr.’s recent statements of the BSP considering a “strong follow-through monetary adjustment” in August. We believe a 50bps rate hike would be justified to temper rising inflation expectations and second-round inflationary effects. Alongside the policy rate hike, the overnight deposit and lending rates will also increase accordingly. Since inflation will likely remain above the target range but would probably start to decelerate in Q4 this year, we think August’s monetary policy statement will contain a hawkish tone. Meanwhile, we no longer expect more cuts in the reserve requirement ratio (RRR) for the remainder of this year. This is according to BSP Governor Espenilla who said on 26 July that the central bank has “done enough” with the 200bps RRR cuts for the year. However, we expect BSP to resume with RRR cuts next year as mentioned by the central bank governor.
Domestic liquidity, bank lending growth cooled in June. M3 money supply growth cooled to 11.7% yoy in June from 14.3% in May while bank lending growth (net of reverse repurchases) edged down to 19.1% from 19.3% in the same period.
Total funds placed in the reverse repurchase, overnight deposit, and term deposit facilities dropped by P79b in June, to end the month at P444b. Lower funds were evident in overnight deposit facility (ODF) and term deposit facility (TDF) that were partly offset by a monthly increase in funds in reverse repurchase facility.
TDF weekly auctions in July saw an increase in the bid-coverage ratios for the 14- and 28-day tenors and a decline for the 7-day tenor. The TDF’s weekly auction volume was unchanged at P100b in July.
H1 fiscal deficit below program, 2019 deficit target raised. H1 fiscal deficit of P193 billion (estimated at 2.3% of GDP) is 27% less than the government’s program. Although cumulative growth of revenue collections and disbursements was the same at 20% yoy, the former outperformed the latter in meeting the target, resulting in a less-than-programmed fiscal deficit. We maintain our 2018 fiscal deficit forecast of P440 billion (2.7% of GDP). Meanwhile, the Development Budget Coordination Committee (DBCC) revised up its 2019 fiscal deficit program to 3.2% from 3.0% of GDP. The adjustment took into account the government’s desire to maintain its aggressive disbursements in order to sustain the Build, Build, Build program. In contrast, IMF recommended the fiscal deficit for 2018 and 2019 to be kept at 2.4% of GDP in order to temper inflationary pressures.
The 2019 national budget proposal was submitted by President Rodrigo Duterte to Congress after delivering his State of the National Address (SONA) on 23 July. The proposed P3.76 trillion budget (19.3% of GDP) was approved by the Cabinet on 9 July. It is a cash-based budget with P875 billion (4.5% of GDP) allotted for infrastructure. However, it doesn’t take into account the Supreme Court decision for the national government to increase revenue share of local government units (LGUs) as well as the promulgation of the Bangsamoro Organic Law. We estimate the additional costs that would come from the implementation of the Court ruling and the BOL to potentially raise the fiscal deficit to 4.2% of GDP in 2019; if this materializes, this would pose a risk of a credit rating downgrade.
Sovereign ratings affirmed, rating outlook stable. Moody’s and Fitch have affirmed their Philippine ratings at Baa2 and BBB, respectively, with both also maintaining a stable ratings outlook. Moody’s took note of the country’s “high economic strength” based on fast growth and moderate public debt. However, it cited government’s plans to shift to federalism as well as the Supreme Court ruling on LGU revenues as downside risks. On the other hand, Fitch gave a “favorable growth outlook” and also took note of the low public debt, but identified “some overheating risks” emanating from inflation, credit growth, and trade deficit.
BTr fully awarded 91-day T-bills, rejected 7Y, 10Y, 20Y T-bonds. GS yield curve bear flattens. Bureau of the Treasury’s (BTr) government securities (GS) auctions in July saw full awards for the 91-day Treasury bills (T-bills), partial awards for the 182- and 364-day T-bill tenors, and rejections for all treasury bonds (T-bond). BTr raised a total of P66.6 billion out of the P75 billion T-bill offering. The average yield for the 91-day T-bill went down throughout the month whereas it moved upward for the other two tenors. Moreover, BTr rejected bids for the 7-, 10-, and 20-year T-bonds. Meanwhile, GS yields moved up further for all tenors along the curve in July, except for the 3-month security. The yield increase during the month ranges between 1 and 28bps. On a year-to-date basis, GS yields increased by an average of 103bps. The GS yield curve bear flattened in July.
BOP deficit soared, GIR down in H1. The balance of payments (BOP) deficit widened to $3.3 billion (est. 2.1% of GDP) in H1, its biggest level since H1 2014. Six consecutive months of BOP deficits have led its cumulative total to more than double BSP’s full-year forecast of $1.5 billion. We observe that the relatively huge trade-in-goods deficit as well as financial capital outflows were likely the main reasons that led to the greater-than-projected BOP deficit.
We think the current account deficit has persisted in H1. In Q1, the deficit in the current account was $208m or 0.3% of GDP. In Jan-May, the merchandise trade deficit widened 55% yoy to $15.8b as exports were down 5% but imports grew 10.9%, while overseas Filipinos (OF) cash remittances rose 4.2% yoy to $11.8b.
Moreover, we believe the BOP’s financial account has remained in a net outflow position. In Q1, net outflows in portfolio and other investments outweighed net inflows in foreign direct investments (FDIs). Net inflows in foreign portfolio investments was $306.3m in H1 while for FDIs, it totaled $3.2b in Jan-Apr.
We depict that negative monthly changes in gross international reserves (GIR)—which incurred a $4 billion drop year-to-date through June to end the month at $77.5 billion—are highly correlated to BOP deficits. Foreign reserves are still more than adequate in meeting import requirements and external debt obligations.
Peso appreciated 0.5% mom in July, ytd peso depreciation at 6%. USD/PHP closed at 53.095 end-July. End-2018 forecast unchanged at 53.25. The Philippine peso strengthened vis-à-vis the US dollar in July as it appreciated 0.5% mom, thereby reducing its year-to-date rate of depreciation to 6%. We think the BSP’s stance to conduct “strong” monetary adjustment in early August alongside government’s plans to issue foreign currency-denominated bonds, such as Samurai bonds, may have helped attract financial inflows during the month, thereby supporting the peso. We hold on to our end-2018 USD/PHP forecast of 53.25.
Table: Philippine Economic Forecast Summary
Disclosures Appendix
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