Last Monday, headlines echoed a familiar concern: slow economic growth coupled with stable inflation seemingly granted the central bank room for another interest rate cut. Sixteen analysts predicted a 25-basis-point reduction, potentially pushing the policy rate to a more than three-year low. The logic appeared straightforward – growth had faltered, falling short of targets, while inflation remained comfortably within bounds.
But is another cut truly the answer? Monetary policy isn’t automatic; it demands careful judgment. A more critical question arises: has further easing become less effective, and potentially, more dangerous?
The core of the growth problem isn’t simply a matter of monetary policy. Despite a substantial 200-basis-point reduction in policy rates, economic growth continued to decelerate. Private household spending, the engine of the economy, slowed even as inflation fell, suggesting a deeper issue at play.
The problem isn’t that inflation is low, but that prices remain stubbornly high relative to income. While inflation rates may have moderated, the absolute cost of essential goods – food, transportation, utilities – hasn’t returned to previous levels. This isn’t a monetary issue; it’s a structural one, rooted in logistical inefficiencies, trade barriers, and agricultural vulnerabilities.
Even substantial remittances, exceeding $32 billion in the first eleven months of the year, failed to ignite a surge in spending, hinting at underlying caution and diminished confidence. Investment growth plummeted, signaling a crisis of trust that liquidity alone cannot solve. Interest rate cuts cannot compensate for uncertainty or build essential infrastructure.
The banking system is awash in liquidity, thanks to reserve requirement reductions and rate cuts. However, this hasn’t translated into a significant increase in lending. In fact, real lending rates have actually risen, with high-end rates climbing even as policy rates fell. Banks remain hesitant, tightening credit standards despite the easing cycle.
This weakened transmission of monetary policy means further rate cuts may yield diminishing returns. If liquidity doesn’t translate into credit expansion, the impact of additional easing shrinks, and the risks begin to outweigh the potential benefits.
The narrative of benign inflation may be dangerously backward-looking. Mounting supply-side risks – rising utility costs, potential toll increases, and adjustments to water rates – threaten to quickly undermine expectations. These aren’t marginal concerns; they ripple through the economy, impacting transportation, logistics, and household expenses.
Reversal of rice import policies poses another significant threat. Rice carries a heavy weight in the consumer basket, and even modest price increases can have a disproportionate impact on inflation expectations. The exchange rate is also vulnerable, its recent stability partly reliant on expectations of an easing cycle’s end. Continued cuts could trigger capital outflows and a weaker peso, fueling imported inflation.
Positive base effects from extremely low inflation in 2025 will also contribute to upward pressure in 2026. Combined with existing cost pressures, the likelihood of breaching the inflation target band is increasing. The central bank’s current forecast may prove overly optimistic.
Crucially, inflation expectations are at risk of becoming unanchored. Households aren’t swayed by complex economic models; they react to rising tolls, electricity bills, and food prices. Once expectations drift upward, restoring credibility requires far more aggressive tightening later. Prevention is far more effective than correction.
Flexible inflation targeting requires a calibrated response. While the central bank has successfully anchored price stability since 2002, flexibility shouldn’t equate to asymmetry. Leaning too heavily toward growth support when transmission is impaired and inflation risks are rising can erode credibility, gradually and then suddenly.
A central bank’s most valuable asset isn’t liquidity, but credibility – a cumulative, yet fragile, quality. Continuing to ease when structural issues restrain investment and productivity risks asset mispricing, currency instability, and ultimately, abrupt tightening cycles. Monetary policy can buy time, but it cannot manufacture confidence.
A strategic pause isn’t a sign of weakness, but of strength. It acknowledges diminishing returns, recognizes rising inflation risks, and prioritizes credibility and exchange rate stability. The central bank can always ease again if conditions worsen, but reversing an inflation resurgence or stabilizing a disorderly peso is far more costly.
Sometimes, the most powerful action a central bank can take is restraint. Agility, not momentum, is the hallmark of effective flexible inflation targeting. Growth is important, but price stability and the credibility that underpins it are indispensable. Once credibility is lost, restoring it is a monumental task.
