The Philippines, a monetary policy story on fragile foundations

Our recent research trip to Manila left us with a constructive view on the Philippines’ monetary policy and a more cautious one on what surrounds it.

The central bank is acting early, the government is on course to deliver the deficit it promised, and a dated political catalyst is approaching with an unusually favorable shape. At the same time, the external accounts are under pressure and the political risks that matter most over the next two years are still building. In our view, the policy rate is the most reliable anchor in the Philippines today, and the picture further out the curve depends on how fiscal, funding and political questions are resolved.

A central bank ahead of the problem

The Bangko Sentral ng Pilipinas (BSP) has raised its policy rate by 75bp since April to 5.00%, and it did so before second-round effects had taken hold. Headline inflation peaked at 7.2% in April and was 6.1% in August, while core inflation is 4.1%. The central bank’s own staff put the neutral real rate at 1 to 2%, which means policy is positive in real terms against core inflation and still negative against the headline.

That gap is the source of our confidence in the carry. The BSP has room to do more if rice prices, wages or El Niño require it, and it has made clear that it will look through weak growth to protect inflation expectations. We do not expect cuts before the second quarter of 2027 at the earliest, and one more 25bp move on October 22 is a realistic outcome. For investors, that means a central bank that is credible, predictable and leaning against the risks, alongside a front end that pays well to wait.

Inflation has peaked, but has not yet been beaten

The pressure has come from supply rather than demand, which is why we think it is temporary. A fuel price shock after the Middle East conflict began, a surge in rice prices, up 19.4% YoY in August with the country importing about a quarter of its rice, and minimum wage increases in Manila have driven the headline.

The BSP expects inflation to peak this year, and the officials we met were measured about the risks. Wage pass-through outside Manila has been smaller than feared, while the El Niño effect on prices has so far been limited. They see room for inflation to ease as base effects begin to work in the spring of 2027.

We agree with the direction, but we are not assuming a straight-line path. Weather agencies put the odds of a strong El Niño in the fourth quarter at 92%, and a drier winter would test rice prices again. That gives the BSP another reason to remain vigilant and reinforces our preference for shorter maturities over longer ones.

Growth takes the strain, credibility holds

The cost of this policy mix is growth, which slowed to 2.3% in the second quarter as public construction and investment contracted. We see this as the price of rebuilding discipline after last year’s flood control scandal, rather than as a structural break.

Controls on infrastructure spending are tighter, the pipeline of projects is being re-awarded, and the external sector is strong, with exports rising 27.8% YoY in August, led by electronics. On the fiscal side, the government is on course to deliver its 5.4% of GDP deficit target this year and is targeting 5.1% in 2027, with debt-to-GDP peaking around 65%.

We note that part of this consolidation comes from slower capital spending, so the quality of the adjustment remains something to watch. Funding is a strength for now. The Treasury has already raised more than 80% of its 2026 programme, while the arrival of Philippine bonds in the JPMorgan GBI-EM index on January 29 should bring new international demand to the market.

Fiscal discipline, with a caveat

Officials were consistent that the 5.4% deficit target for 2026 will be met, while the 2027 budget targets 5.1%, on a path toward 3.5% by 2030. That provides investors with a clear fiscal anchor.

The caveat, raised candidly by multilateral participants, is how the government gets there. A large part of the later adjustment relies on lower public investment, precisely the part of the budget that supports potential growth, while the revenue measures identified so far are modest. We do not see this as a problem for 2026 or the first half of 2027. We do see it as a reason why the long end of the curve deserves a premium.

A market built for carry

The structure of the local bond market points in the same direction. Domestic banks hold about 40% of local government debt, and roughly half of recent trading volume is in bonds with less than one year to maturity. Liquidity beyond five years remains thin, and investors told us it has not improved since the spring.

The regulator’s temporary capital relief on valuation losses for banks, which runs until the end of the year, has supported the banking system’s appetite for government bonds, and an extension would be a clear positive. In a market with this structure, we would rather be where the volume and the central bank’s attention are, at the front end, than where liquidity is scarce and the 2027 supply lands.

Funding, done for 2026, heavier in 2027

The Treasury front-loaded its borrowing and has little left to raise this year, leaving the market well supported through the fourth quarter. Next year is different. Gross financing rises by about 21% to PHP 3.3tn as maturities increase.

The Treasury is aware of the issue and is working on liquidity and pricing reform, but we would expect the heavier calendar to fall mainly on longer bonds and weigh on them first. That is the second reason, alongside the political calendar, that we prefer to keep duration short for now.

The Peso managed, not defended

The external accounts are the main area where we see less to like. The balance of payments was in deficit by USD 5.9bn from January to August, remittance growth has slowed to about 2%, and reserves, at roughly USD 105bn, are below their February peak.

The BSP told us that it intervenes against disorderly moves and does not defend a level. We therefore expect a gradual, modest depreciation in the peso rather than a sharp move. There are offsets. Around USD 4bn of programme loans are still to be disbursed, while index inclusion in January should bring inflows. A conviction in the Senate trial would likely provide an additional short-term lift. We would treat that as an opportunity to reduce exposure rather than as a change in trend.

The impeachment verdict is priced for worry, not for relief

The Senate trial of Vice President Sara Duterte is expected to reach a verdict in November or December, and it is the first dated catalyst in years with a distinctly asymmetric payoff profile. Local analysts told us that a significant political premium is already embedded in Philippine assets.

If she is convicted, we would expect that premium to unwind quickly, with the peso and government bonds rallying strongly. If she is acquitted, the market will largely have expected it and prices should move little, although she would remain the front-runner for 2028.

The outcome is genuinely uncertain. Conviction now requires 14 votes from the 20 senators able to take part, and the voting is not public. That leaves a catalyst where the potential reward from a conviction is larger than the cost of being wrong, which is why we think a small tactical position in the peso is justified around the event.

Why we remain concerned on the politics and what would change our view

We would be careful not to overread the verdict. Our meetings left us with the clear view that Sara Duterte is not her father. She is the more dangerous political figure and considerably less market-friendly.

Even a conviction is not a regime change. Her brother Sebastian is the family’s backup, and in our view the Duterte camp would still be the favourite in 2028, while the centrist and conservative parties have very little chance based on the evidence today.

A Duterte presidency would likely bring the Philippines much closer to China and further from the United States. That matters for a country where roughly 40% of remittances come from the US and where the new foreign investor base is predominantly Western. Political risk will rise as the election gets closer, and the market is likely to start pricing it again well before the vote.

We would be more comfortable adding duration if several conditions came together: a BSP pause on October 22 with guidance that policy is adequate; rice and core inflation turning lower; an extension of the bank capital relief; visible improvement in secondary market liquidity; and international participation in the market moving closer to that of other ASEAN peers. The pricing reform for government bonds that the Treasury told us about would also help.

We would become more cautious on the carry if the BSP signalled a series of hikes, if the dry spell pushed rice inflation above 20%, or if the capital relief were allowed to lapse with yields near current levels.

Bottom line

The Philippines offers what we want from a rates market in this environment: a central bank that is credible and moving early, a government that is meeting its deficit target, a market with a new source of demand arriving in January, and a catalyst with an attractive payoff.

Against that, the external accounts remain under pressure, with the balance of payments in deficit and the peso drifting weaker. The 2027 funding calendar is heavier, while political risks are elevated and still building. That mix does not yet give us enough comfort to add duration.

We would rather earn the carry at the front end, let the October 22 BSP meeting, the bank capital relief decision at year-end and the impeachment verdict pass, and extend once more of that uncertainty has cleared. If the right pieces fall into place, there should be a point to move further out the curve. We do not think we are there yet.