MANILA - The Philippine market reacted cautiously yesterday to the central bank's unexpected decision to raise overnight interest rates, for the third time this year, by 25 basis points, dealers said.

Joseph Roxas, president of Eagle Equities, said the bank's latest move was like "taking oxygen from a patient who can't breath."

"The type of inflation we have now is called cost-push inflation. Higher interest rates will only raise costs even further, not reduce them.

"The bank should be lowering interest rates to help spur economic activity."

The central bank's overnight borrowing rate stands at 7.50 percent and the lending rate at 9.75 percent after the hike, late Thursday, and interest rates are now at their highest level since 2002.

The decision caught financial markets by surprise as most analysts did not expect the bank to raise rates until next month.

In a statement, central bank governor Amando Tetangco said data suggests a possible breach of the inflation target in 2007 due to potential second-round effects generated by supply-side pressures, primarily higher crude oil prices.

"Because monetary action normally requires 15 to 21 months to take their full effect on inflation, policy measures undertaken now will help address the risks to inflation and inflation expectations in the coming year and in 2007," Tetangco said.

He did not say what the central bank's inflation target was for 2007, but noted that next year's inflation goal of 7.5 percent is now under review for possible upgrade.

The Philippines' consumer price index grew 7.0 percent year-on-year in September, its slowest since August 2004, due to tamer increases in the prices of food and utilities. In August, inflation stood at 7.2 percent.

For the first nine months, inflation averaged 7.9 percent, well ahead of the government's full-year target of 5.0 to 6.0 percent.

The government is set to implement starting November 1 the new value-added tax law, a development that could further drive up consumer prices as the tax measure removes the VAT exemptions of certain key sectors.

It also gives President Gloria Arroyo authority to raise by January the VAT rate to 12 percent from 10 percent currently.

Meanwhile, Tetangco also cited continued "rapid growth" in domestic liquidity behind the decision to increase rates. "Available data suggest that the financial system remains very liquid despite the recent increase in the policy rate and the reserve requirements, and that the additional liquidity in recent months has been fueled by both foreign exchange inflows and by the deposit generation activities of banks," Tetangco said.*AFP

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