Philippines' sin tax move drove inflation up

Alcohol and beverages rose 17.4% vs 5.1% in December.

According to HSBC, despite strong growth momentum, January headline inflation reading was benign and at the bottom of the BSP's 3-5% target. 

The implementation of the sin tax drove up alcohol and tobacco prices, which lifted core inflation. While the impact is a one-off, still-high domestic demand, an unfavourable base effect, and strong signs of a global recovery suggests that upside risks to headline inflation are high.

As such, the BSP is expected to hold main policy rates steady to monitor the impact of January's SDA rate cuts.

Here's more from HSBC:

Headline inflation accelerated to 3.0% y-o-y in January (Bbg: 3.0%; HSBC: 3.1%; Prior: 2.9%). On a seasonally adjusted basis, inflation rose 0.2% m-o-m sa in January from 0.1% in December.

Core inflation rose 3.6% y-o-y in January from 3.3% in December. On the month, core prices rose 0.5% m-o-m sa from 0.1% in December. Alcohol and beverages, which has a 2% weight in the CPI basket, rose 17.4% y-o-y in January from 5.1% in December.

Food inflation increased 2.3% y-o-y in January (Prior: 2.3%). On a seasonally adjusted basis, food prices declined 0.3% m-o-m sa from an expansion of 0.1% in December.

The BSP inflation target is 3-5% for this year.

The BSP started the year with a bang by lowering the SDA rates by 50-65bp at the January monetary meeting. The below-target inflation reading in December gave monetary officials scope to do so. While the motivation was primarily to save costs, the drastic reduction of interest rates would likely have a stimulative effect on the economy as banks diversify their investments elsewhere.

The question is how significant this effect would be. While today's inflation reading is still benign, the BSP will likely hold main policy rates steady to monitor the impact of its decision. More macro-prudential measures targeting "speculative inflows" are likely to be implemented.

The February inflation reading would be an important one to watch, as an unfavourable base effect is expected and the BSP would examine the details carefully prior to its March meeting. In January, food inflation was subdued, supported by an abundant supply of food.

Core inflation rose significantly but the expansion was mostly due to implementation of the sin tax, which drove the sharp acceleration of the alcohol and beverages prices. We expect this effect to be a one-off factor.

Two main factors are keeping headline inflation at the bottom of the BSP's target: benign food and transportation prices. However, Brent crude oil prices have risen as of late, and should this trend continue, we could see a pick-up of transportation prices (7.8% of the CPI basket).

Domestic demand does not need lifting at the moment. The 4Q2012 growth print shows that private consumption accelerated from 3Q2012. With interest rates at a record low, remittance inflows robust, and fiscal spending supportive, the growth momentum will likely continue in 2013.

While the BSP is vigilant on a potential asset bubble and sharp acceleration of headline inflation, the still-benign inflation reading in February would suggest that the monetary board might consider a further reduction of SDA rates to save costs. But with recent data from China and the US suggesting a pick up in global growth
momentum, the BSP is inclined to be prudent and stay on hold in March to further monitor external and internal conditions.

While the January headline inflation reading was benign and at the bottom of the BSP's 3-5% target, still high domestic demand, an unfavourable base effect, and strong signs of a global recovery suggest that upside risks to headline inflation are high. Therefore, we expect the monetary board to hold main policy rates at 3.50% at the next meeting.