3 reasons behind Philippines' inflation surge

The 3.8% increase is not to blamed solely on the recent nasty weather conditions.

According to HSBC Global Research, August headline inflation increased 3.8% y-o-y from 3.2% in July (Bbg: 3.5%; HSBC: 3.7%). On a sequential basis, month-on-month inflation rose 0.6% seasonally adjusted (sa) from 0.4%.

Here's more from HSBC:

Core inflation, stripping out food and energy, rose to 4.3% y-o-y from 4.1% in July. On a month-on-month basis, core inflation increased 0.4% m-o-m sa from 0.6% in July

Food prices accelerated to 3.3% y-o-y from 2.3% in July. On a sequential basis, food inflation rose 0.9% m-o-m sa from 0.4% in July.

Implications
The rapid uptick of prices in August was due to three main reasons: 1) short-term food supply shocks from the floods; 2) higher domestic oil prices, which translated to higher transportation costs; 3) still very elevated domestic demand, which drove up the costs of core items, stripping out food and transportation. While the BSP remains "mindful of weather, calamity-related disturbances as it affects supply," it would not be able to deny the elevated costs of commodity prices such as oil as well as pent-up demand in the economy.

The BSP will have a few things to consider when it next meets on 13 September. Global prices continue to be elevated despite sluggish growth momentum; the actions of the FED; external demand will likely prove weak in the third quarter; but domestic demand in the Philippines will stay strong. While these other considerations matter, the higher-than-expected headline inflation August number will motivate monetary officials to keep rates on hold.

Despite anemic growth globally, the Philippines' GDP exceeded expectations by expanding 6.1% in the 1H. A slowdown is expected in the 2H, but the economy would still hold up well, as fiscal spending is robust; remittances are resilient; PPP projects are picking up; and service exports would likely offset lackluster goods exports.

The strong growth momentum as well as a likely pick up of inflation in the 1Q2013 will prompt the BSP to keep rates on hold. While headline inflation is still within the 3-5% target and unlikely to breach the upper bound in 2012, headline inflation is trending upward. Most worryingly is the unfavorable base effect in the 1Q of next year - should it be coupled with high demand and global commodity prices, the target would be breached. As such, with rates already at a historic low, the economy humming along healthily and inflation on the track to rise, the BSP will likely keep rates on hold to monitor external and price conditions.

Bottom line
Headline inflation rose at the fastest pace since January due to higher food, fuel and domestic demand. With growth momentum strong and inflation likely to accelerate sharply in 1Q2013, the BSP will hold rates steady at the next meeting to monitor price conditions.