A STRONGER peso provides limited relief to inflation, according to a study by the Bangko Sentral ng Pilipinas (BSP), noting that while a weak currency pushes prices higher, peso gains do not necessarily translate into comparable price declines.
“We found that there is asymmetry in the pass-through to inflation between appreciation and depreciation episodes, both in the short and long runs,” the central bank said in its latest discussion paper.
It is a given that when the peso depreciates, inflation rises as higher import costs for food, fuel and intermediate goods are passed on to consumers. However, the study said that when the peso strengthens, prices tend to be sticky, reflecting a reluctance among businesses to reduce prices even as costs ease.
This helps explain why households often feel price increases more acutely than price declines.
Using quarterly data up to fourth quarter of 2024 and applying nonlinear econometric models, BSP economists found that during the inflation-targeting period, a 1-percent quarter-on-quarter peso depreciation leads to an average 0.10-percentage-point increase in inflation in the short run, and as much as 0.75 percentage point in the long run.
In contrast, peso appreciation was found to have no statistically significant impact on inflation in the short and long runs.
The paper further showed that inflation risks intensify for large peso depreciation. Once quarter-on-quarter peso depreciation exceeds about 1.28 percent, the pass-through to inflation becomes statistically significant.
Smaller exchange rate movements, as well as peso appreciation — even when sizable — do not greatly affect inflation outcomes.
“These findings suggest that inflation risks are skewed toward depreciation episodes,” the paper said, noting that downward price stickiness limits the disinflationary effects of a stronger currency.
Exchange rate pass-through decline
Nonetheless, the study confirmed that exchange rate pass-through has declined since the Philippines adopted an inflation-targeting framework in 2002. It noted that inflation volatility fell, with the standard deviation decreasing from 4.1 percent to 2.0 percent in the same period.
Even after accounting for asymmetric effects, the inflation impact of exchange rate movements during the inflation-targeting period is significantly lower than in the pre-2002 period, reflecting stronger policy credibility, better-anchored inflation expectations and structural reforms in the foreign exchange market, said the study.
“The inflation environment became more manageable as the peso strengthened due to FX (foreign exchange) inflows, while global commodity prices eased due in part to subdued global demand conditions,” it pointed out.
However, the limited inflation relief from peso appreciation is a challenge for policymakers.
“Exchange rate developments, particularly depreciation episodes, require close monitoring as the risk of inflation is amplified when there are large, positive movements in the exchange rate,” the study said.
The findings suggest that monetary policy responses may need to be more vigilant during periods of sharp peso weakness, when inflation risks are amplified, while being less reactive during appreciation episodes, given their muted impact on prices.
“The BSP could lean toward stronger monetary policy response during large depreciation episodes as the pass-through to inflation is estimated to be higher,” the study said.