MANILA, Philippines – The peso is widely expected to gain more strength this year against the US dollar, but analysts see a bumpy ride for the local unit ahead of the May 10 national elections.

A downward pressure is also seen to persist on the peso during the early part of the year as the greenback may continue to recover on bets the Federal Reserve will raise interest rates and withdraw stimulus measures this year, they said.

Analysts see the peso ending the year with expected gains “muted” by persistent concerns about the Philippines’ “deteriorating” fiscal position.

Dollar inflows such as remittances of Filipinos abroad and foreign portfolio investments expected, especially after the May elections, should give a further boost to the peso this year, according to analysts at First Metro Investment Corp. (FMIC) and University of Asia and the Pacific (UA&P).

However, they said: “The rebound of the US dollar as early as the first quarter will more than offset these appreciation boosters, resulting in a 2-percent average weakening of the peso” by end-March.

The peso settled at 46.20 on the last trading day of 2009, up 2.8 percent in a year that saw the local unit shifting gears several times as investor sentiment remained volatile.

The still-rising remittances last year, particularly the strong inflows in the last quarter, kept the peso in the winning column, as it rose from its end-2008 level of 47.52.

The modest gain also reflected a broadly weak dollar throughout the year.

The dollar, however, regained strength against major currencies during the New Year holidays, advancing to a three-month high against the yen and rallying versus the euro on expectations the Fed will withdraw stimulus measures soon as US unemployment rate is seen starting to stabilize this year.

Bloomberg News reported on January 1 that the futures trading in Chicago on December 31 showed a 62-percent chance that the Fed will raise its target lending rate by at least a quarter-percentage point by its June meeting, up from 31-percent odds a week ago.

The Fed held the target rate for overnight lending between banks at zero to 0.25 percent on December 16 while saying “economic activity has continued to pick up.”

In the Market Call’s December issue—a joint report of FMIC and UA&P on financial markets—analysts said the peso was expected to drop to 46.91 this month, and further to 46.98 next month and 47.15 in March.

“Muted” gains, however, are expected for the peso ahead of the May 10 elections, according to DBS currency strategist Philip Wee.

“Bets on the peso, which is supported by an improving international liquidity position, will be muted until we get a positive outcome at the Philippine presidential elections,” he said.

He sees the exchange rate hitting 45.2 per dollar by the end of March, 44.8 by end-June, 44.8 by end-September, and 44.0 by end-December.

Wee said the Indian rupee was likely to perform better than the peso while election-related uncertainties in the Philippines prevail. “Although India has a current-account deficit versus a surplus in the Philippines, foreign reserves are still higher than external debt in the former, and not in the latter.”

The rupee, he said, should benefit from capital inflows into equities on the back of higher economic growth.

But, he said, “the advantage should shift from rupee to the peso in the final quarter of the year,” when remittances traditionally pick up.

“We see scope for the peso to recoup more of its losses from the global crisis,” Wee said, noting that by early December 2009, the local unit had already recouped 38.2 percent of its losses.

For 2010, he said the retracement would likely be deeper at 61.8 percent.

“To turn more bullish, we need the May elections to produce a new president [who] can lead a government to take advantage of the positive Asian environment to put the country on a faster growth path,” he said.

The next 12 months may see the local unit trading between 45 and 48, according to Marcelo Ayes, senior vice president for financial markets at Rizal Commercial Banking Corp.

The peso may be under downward pressure in the first quarter because of reduced remittance flows compared with the previous quarter, he said. But it is likely be supported in the second quarter when remittances pick up ahead of the school opening.

Ayes sees an end-2010 exchange rate of 46.00 per dollar, with gains muted by persistent concerns about the Philippines’ fiscal deficit, which is seen hitting P293 billion this year, exceeding the still-official target of P233.4 billion.

CLSA Asia-Pacific Markets, a Hong Kong-based investment house agrees, saying the Philippines’ “deteriorating” fiscal position was expected to temper the peso’s gains this year.

“This leaves us forecasting a 2010 year-end exchange rate of 46 and 45 for end-2011,” said CLSA senior economist Sharmila Welan. “With interest rates rising and economic fundamentals strengthening this point to a stronger peso, and this is what we have in our forecasts.”

Currency trading on the electronic platform of the Philippine Dealing & Exchange Corp. resumes on Monday after a four-day New Year holiday.