TOKYO - Investors contemplating the Philippines should add inflation to the list of hazards. A fresh rise in bond yields since Feb. 8, when the central bank left borrowing costs unchanged, suggests Manila is falling behind the curve as the economy expands rapidly and the peso hits 11-year lows.

Benchmark 10-year bonds have fallen sharply in price over the last four months. They now yield nearly 6.9 percent, up 44 basis points since the Bangko Sentral ng Pilipinas meeting. Markets are teeing off a disconnect between what the bank is saying, and what it is not doing.

Consumer price inflation unexpectedly spiked to 4 percent year on year in January, from 3.3 percent a month earlier. Yet Governor Nestor Espenilla’s team held fire even as it said CPI will top 4.3 percent this year, above the 2 percent to 4 percent target.

BSP staffers are betting gains will be transitory and upward pressure on prices will recede by 2019. The rise partly reflected excise-tax increases introduced in December on food, drinks, tobacco and other items.

This smacks of wishful thinking. The Philippines has grown north of 6 percent annually since mid-2015, boosting demand and pricing power. Import inflation abounds, too. As part of President Rodrigo Duterte’s infrastructure boom, the Philippines is gorging on overseas raw materials just as global prices are heating up. Imports surged 17.6 percent year on year in December, leading to a record $4.0 billion trade deficit.

Overseas purchases, including oil, are being made with the worst-performing emerging-market currency after Argentina. Some of the peso’s weakness reflects worries about Duterte’s bloody drug war and assault on government institutions. A worsening trade imbalance could weaken the peso further, creating more inflationary pressure.

Rising inflation expectations could prove self-fulfilling, prompting higher wage demands and in turn higher prices. If the BSP loses control, the spike in bond yields will accelerate, slamming stock values.

The central bank could start to get a grip by raising its 3 percent benchmark rate at a March 22 policy meeting. Given the 12- to 18-month lag between monetary actions and real economic impacts, it needs to get moving.

CONTEXT NEWS

- The central bank of the Philippines, Bangko Sentral ng Pilipinas, last raised its key policy rate in September 2014, when it increased rates 25 basis points.

- On Feb. 8, the central bank projected average inflation would moderate to an annual rate of 3.5 percent in 2019 from 4.34 percent in 2018. Governor Nestor Espenilla said the bank expected inflation to “moderate and settle” next year to within its target range of 2 to 4 percent.

- President Rodrigo Duterte plans to spend $180 billion on infrastructure in his six-year term, overhauling Manila’s airport and upgrading ports, roads, rail links and irrigation. He wants to raise annual spending on such projects to 7 percent of GDP, well above the 5 percent average of neighbouring countries.

- William Pesek is a Tokyo-based journalist, former columnist for Barron’s and Bloomberg and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.”

(Editing by Quentin Webb and Katrina Hamlin)

© Reuters News 2018