Asia’s central banks are bracing for the Federal Reserve to lift interest rates this month for only the third time in a decade.
Higher U.S. borrowing costs ripple through Asia by driving up bond yields, reducing the region’s appeal to foreign investors and thereby pressuring local currencies. In response, some Asian central banks historically have faced pressure to shield their economies with rate hikes of their own.
This time around, the prospect of U.S. tightening has coincided with an upswing in China’s producer price inflation to all but snuff out thoughts of further significant monetary easing in Asia. But whether the region falls into lock-step with the U.S. is another matter altogether as domestic challenges argue for continued monetary accommodation.
“We think most central banks in Asia will look through the recent rise in inflation and keep monetary policy accommodative,” said Gareth Leather, senior Asia economist at Capital Economics Ltd. in London. “More favorable base effects mean fuel inflation in Asia should start to drop back sharply in the coming months.”
Indeed, economists still see potential for some modest easing this year in Australia, India and South Korea, according to the latest surveys by Bloomberg. Here’s a look at how Asia’s major central banks are placed ahead of next week’s Fed meeting.
China is boosting money-market rates as a way of containing company leverage. Doing so allows the People’s Bank of China to deflate asset bubbles without derailing the underlying economy by jacking up benchmark rates. It also shores up confidence in the yuan and discourages companies and savers from shifting their money overseas.
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The government set a 2017 growth target of “around 6.5 percent, or higher if possible,” Premier Li Keqiang said in his work report to the annual National People’s Congress gathering in Beijing. While Li also announced a lower target for monetary expansion, analysts at UBS Group AG say the equivalent of $3.3 trillion could still be added to the total amount of money swirling around the economy this year.
Fed hikes should take pressure off the BOJ to add yet more stimulus by weakening the yen and driving up the cost of imported goods, helping the Bank of Japan’s reflation quest. BOJ Governor Haruhiko Kuroda may be a long way from tightening, but at the very least these developments may mitigate against additional easing as was unleashed through 2016.
But the prospect of higher U.S. rates isn’t all good news for the BOJ. As Treasury yields climb, more pressure may build on the 10-year bond yield in Japan, making it ever tougher and more expensive for the BOJ to keep that yield at around zero.
India’s central bank last month unexpectedly left borrowing costs unchanged for a second straight meeting and signaled that its two-year interest-rate easing cycle is coming to an end. The Reserve Bank forecast a sharp recovery in growth during the year through March 2018, helped by a rebound in consumption that has been hurt by Prime Minister Narendra Modi’s unprecedented cash ban. A rebound in demand, a bumper harvest that will lead to higher rural incomes and higher salaries for public servants are likely to fuel inflation.
“We expect CPI inflation to rise back above 5 percent in the second half of 2017,” said Priyanka Kishore, lead Asia economist at Oxford Economics, Singapore. “Indeed, the RBI may hike 25 basis points towards the end of the year, if inflation and growth pick up as we expect.”
But the picture is far from uniform. While some economies may be forced to raise rates, others, such as South Korea and Taiwan, may yet need to cut again. In Korea, an unfolding political crisis and deepening tensions with China threaten to dent growth. Meantime, export-dependent Taiwan could find itself stuck in the middle of any U.S.-China spat.
Bank of Korea Governor Lee Ju-yeol last month said U.S. rate increases will put upward pressure on South Korean market yields, but this isn’t the only factor affecting policy and there’s no need for the BOK to “mechanically” raise rates in step with the Fed. Steady inflation allows Taiwan more flexibility in monetary policy, according to its central bank Governor Perng Fai-nan.
Southeast Asian central banks are focusing on core measures of inflation — which exclude volatile items such as energy and food costs — that remain largely contained. This is taking the pressure off central banks to tighten policy for now.
The Philippines, which had the fastest economic expansion in Southeast Asia last year, may be the first country in the region to tighten monetary policy this year, according to economists surveyed by Bloomberg. Inflation is running at the fastest pace in two years and the currency is the worst performer in Asia this year.
In Australia, the central bank has indicated that already record low interest rates won’t be eased further in the near term and said while it expects the Fed to tighten, it isn’t expecting any additional monetary easing in the other major economies. It held borrowing costs steady on Tuesday.
Taken together, while a Fed move will pressure its Asian counterparts, it’s unlikely they’ll need to respond immediately. Healthy foreign-exchange reserves also offer a buffer.
“Adjusting with the Fed makes sense, but different countries in Asia face different domestic issues,” said Warwick McKibbin, a non-resident Senior Fellow at the Brookings Institution in Washington and a former member of Australia’s central bank board.
There’s also no shortage of risks. If Donald Trump ratchets up trade tensions with China, it would ricochet by slowing exports and growth from Japan to Singapore. Any hit to China’s economic and market stability could take the steam out of commodity prices and inflation.
Such uncertainty will give central bankers pause, said David Fernandez, head of fixed-income, currencies and commodities research for the Asia Pacific region at Barclays Plc.
“Domestic inflation, and not the Fed, at this point is the most important consideration for Asian central banks,” he said. “Our baseline is that Fed hikes would not trigger much, if any, tightening by Asian central banks in the near term.”