Bangko Sentral ng Pilippines decided to keep interest differential between the local and US rates wide by cutting policy rates by only 25 basis points, half the cut expected by analysts.

The local overnight borrowing rate is now five percent compared with three percent in the US.

The wide two percentage point differential will encourage higher investments in peso assets that will help keep the peso strong.

BSP Gov. Amando Tetangco said the US decision to cut rates by half a percent anew is positive for the economy.

"We have a within-target inflation outlook that provides us some policy space, but will continue to monitor related risks, including volatilities in oil and other commodity prices, and shifts in risk preferences of economic agents," he said.

Inflation is likely to reach 3.5-4.4 percent this year, within the 3-5 percent target, and between 2.1-3.3 percent next year, within the 2.5-4.5 percent target, BSP deputy governor Diwa Guinigundo said.

The BSP’s overnight lending rate was also lowered by 25 basis points to seven percent from 7.25 percent while the rates on special deposit accounts were also adjusted accordingly.

The reduction in the key rates, the fourth since July last year, came less than the expected 50 basis points, after government earlier in the day reported the economy grew by a blistering 7.3 percent last year.

While monetary authorities expect inflation to be benign, they see risks fanning out from the volatility of oil and commodity prices in the world market.

"The strong economic growth gives us flexibility to focus on emerging inflation without worrying about the real sector," Guinigundo said.

The Fed has cut its target funds rate by an unprecedented 1.25 percentage points in a just a week to forestall recession in the world’s largest economy.

Guinigundo, however, said interest-rate differentials have become less of a factor for investors than the macro fundamentals.

"Interest-rate differentials are important but it’s much more the macro fundamentals that drive the flows," Guinigundo said.

In the light of an expected $3.5 billion surplus in the country’s balance of payments this year, Guinigundo said the peso will remain firm for the rest of the year.

"If the peso continues to appreciate, it will help us manage inflation more effectively, it will make the cost of importing food and fuel cheaper," Guinigundo said.

Guinigundo said the inflation forecast for the year factors in a probable P125 increase in wages, an extended wet season that could harm farm output, and possible hikes in water and electricity rates.

Guinigundo said base effects could also push inflation higher this year.