INTEREST RATES X RE

Books teach us that central banks (CBs) influence inflation through interest rates. When inflation rises, the BSP hikes its benchmark rate to make borrowing more expensive and slow spending. When inflation cools, it cuts rates to encourage borrowing and spur economic activity. Simple enough.

But real-world finance rarely sticks to textbook rules.

In a conversation with my colleague Ron Acoba (from another venture), he walked me through why BSP rate decisions are increasingly less effective today.

Here’s the simplified chain reaction in a "perfect" world:

The BSP cuts interest rates by 0.25%.

PH Gov't Securities (GS)—adjust downward too, since they're influenced by the BSP’s policy stance.

Bank lending rates (which are usually pegged to GS rates, not directly to the BSP's policy rate) also fall.

Lower borrowing costs lead to more consumer and business spending—fueling growth.

But here’s where things start to break down: US interest rates have an outsized influence on local rates.

Why? Because money flows across borders. And lenders, like all investors, compare returns. If the US Fed offers a “risk-free” return of 5%, then no rational investor would lend to the Philippines at 5% too—we’re an emerging market, and riskier.

An NYU finance professor pointed out that the PH has historically needed to offer a 2% risk premium above the US rate to attract capital. So if US rates are at 5%, Philippine rates need to be around 7% to stay competitive.

The problem:

Even if the BSP cuts its policy rate, our GS may not follow—especially if US rates stay high. Why? Because investors demand that higher risk-adjusted return. If we drop too far below that threshold, capital simply flows out of the country to safer markets. This is also why the peso jumped from 55 to 57 against the dollar after the BSP announced its rate cut in June—investors saw it as a move that narrowed the gap between local and US interest rates.

So while BSP may lower rates, the actual borrowing costs in the market—based on GS yields—may stay elevated. And if banks are still borrowing at high rates, they won’t be in a rush to lend cheaper money to businesses and consumers.