MANILA, Philippines - The Bangko Sentral ng Pilipinas' (BSP) unexpected increase in banks' reserve requirements this week looks to be a signal that authorities are worried that inflationary pressures from global prices are spreading in the robust domestic economy.
The move to drain cash seemed at odds with data showing annual growth in money supply slowed to a three-year low in April, but authorities had allowed liquidity to build up this year as they sought to boost investment and support growth.
Short-term special deposit accounts (SDA) with the central bank hit a peak of P1.51 trillion ($35 billion) in April.
In a strongly growing economy -- seasonally adjusted growth was 1.9% in the first quarter, nearly four times fourth quarter growth of 0.5% -- rising demand can turn that sort of liquidity into inflation pressures and asset bubbles.
"The decision to raise the reserve requirement by one percentage point indicates that the central bank has shifted its policy focus to tackling inflationary pressures stemming from excess liquidity in the system," said Vincent Tsui, an economist at Standard Chartered Bank in Hong Kong.
The central bank raised interest rates at its past two meetings, taking the overnight borrowing rate to 4.5%.
It was expected to raise rates again on Thursday, but held fire. Still, analysts expects rates to rise further in the next six months.
Headline inflation in May was 4.5%, well below market forecasts but higher than a downwardly revised 4.3% in April. Core inflation edged up to 3.7%, the highest since September 2010 but also below market forecasts.
Inflation pressures have mainly come from rising global fuel and food prices, which monetary policy can't directly address, although it can help in containing future price expectations.
But while the central bank has been raising official rates, the extra cash left in the system had pushed market rates to abnormal lows. Average yields at auctions for 91-day and 182-day Treasury bills fell to below 1% in April.
"What we find surprising is why the BSP has taken so long to mop up some of the excess liquidity," said Devika Mehndiratta, an economist at Credit Suisse in Singapore.
"We have been highlighting that policy rate increases are unlikely to mean much more for short-term rates unless liquidity in the system reduces," she said.
Both Tsui and Mehndiratta see room for another increase in the reserve requirement ratio in the second half of the year, restoring the reserve requirements to a pre-global crisis level of 21%.
In late January, the central bank had said the liquidity would help fund growth, and as long as any rundown of funds with it, such as the SDAs, was orderly and put to productive use, it would not necessarily be inflationary.
But on Thursday, the central bank said it was worried strong capital flows and economic prospects could fuel liquidity growth, which it saw as the dominant risk, and so acted to drain an estimated P38 billion from the market.
"A situation where you have excess liquidity could blunt the effectiveness of interest rates moves," Deputy Governor Diwa Guinigundo said on Thursday.
Central bank data showed net portfolio inflows in January to May of $2.01 billion, nearly three times higher than in the same period last year.
The policy decision sparked a mild rally in the debt market, with yields on most liquid tenors down an average 5 percentage points, a trader in Manila said.
"The central bank's decision implies that it was more concerned on liquidity rather than on inflation and that is positive for the bond market," the trader said.