Do Asian central banks have room to cut rates?

Asian central banks are unlikely to cut interest rates in the near term given their foreign exchange stability mandates, concerns over capital flight and lingering upside risks to energy prices.

As inflation continues to move lower, a natural question for investors would be whether Asian central banks have the capacity to cut interest rates to support their economy if momentum in the region were to slow down over the next 12 months.

While Asian central banks may be tempted to ease monetary policy in response to adverse economic conditions, they are unlikely to cut interest rates in the near term given their foreign exchange stability mandates, concerns over capital flight and lingering upside risks to energy prices.

With the Fed staying higher for longer, yield differentials between the U.S. and Asia have widened in favor of U.S. dollar strength and has made Asian yields relatively less attractive. While long-end bonds have rallied in recent weeks, the 10-Year UST yields have risen more than 50 basis points over the period of January to mid-November this year. However, the 10-Year Asian government bond yields have risen to a lesser extent given the more moderate monetary policy tightening cycle witnessed in Asia.

Exhibit 7:

Source: FactSet, J.P. Morgan Asset Management. Data reflect most recently available as of 30/10/23.

 

As a result, economies such as Malaysia, South Korea, Taiwan and Thailand, which until recently were enjoying positive yield differentials relative to the U.S., have now turned negative. In addition, economies such as the Indonesia and Philippines, which used to have substantially wider yield differentials over the U.S., have seen yield differentials shrink significantly over the past year. High UST yields and a weaker currency have therefore reduced the room for rate cuts in the short term.

Asian central banks will also be wary of calling off the fight against inflation too soon. With energy taking up a significant share of the CPI basket in emerging Asia, the potential pass through of higher energy prices may stall further disinflationary pressures. Net energy importers will be particularly wary of the potential pass through of higher energy prices on domestic inflation.

The odd ones out would be China and Japan. While the People’s Bank of China remains in an easing mode, further policy support will be needed on the fiscal side rather than more monetary easing by cutting key policy rates. Japan, on the other hand, is taking nascent steps toward tightening, and there are growing speculations of a move away from yield curve control and negative interest rate policy.

In the long run, should the Fed cut rates in response to slower growth in 2H 2024, Asian central banks would have more scope to cut interest rates to support growth. That said, the decline in UST yields might be more gradual given technical factors and supply and demand dynamics. This could significantly limit the scope for meaningful rate cuts among Asian central banks.