While headline inflation in Asia has been boosted by higher fuel prices and various logistics and supply-side bottlenecks, most central banks still see this to be transitory and core inflation remains subdued.
Chief Market Strategist, Asia Pacific
The Bank of Korea (BoK) raised its policy rate by 25bps last week to 0.75% and it could hike again before the end of the year. BoK policymakers have been hinting at this change for some months, so it was not a surprise. However, with the U.S. Federal Reserve (Fed) expected to start cutting its asset purchases by year-end, investors are concerned that more Asian central banks could also look to normalize policy in the near term.
Beyond the BoK, the Reserve Bank of New Zealand could also be looking to raise interest rates before the end of the year. While it was ready to pull the trigger in the August meeting on the back its hot property market, the latest bout of lockdown policy has delayed its first policy rate hike.
Yet, this is perhaps where the short list of hawkish Asia-Pacific central banks would end.
Starting with China, it began to cool credit growth at the start of the year given the robust progress in overall economic recovery. However, economic data in the summer months have shown that growth momentum is slowing, and small- and medium-sized companies are struggling to get liquidity. People’s Bank of China Governor Yi Gang recently pledged to boost credit support for the economy and help to reduce lending rates for businesses. Additional statements from the central bank suggest another cut in reserve requirement ratio could be on the cards in the near term. This would compliment more fiscal support from central and local governments.
While headline inflation in Asia has been boosted by higher fuel prices and various logistics and supply-side bottlenecks, most central banks still see this to be transitory and core inflation remains subdued. Moreover, most Asian economies are still struggling with COVID-19 and its Delta variant, and the subsequent damage to the domestic economy. Despite the prospect of policy normalization in the U.S., the pressure on Asian currencies is manageable. All these point towards a low policy rate environment going deep into 2022 in most Asian economies.
Indonesia and India have traditionally been vulnerable to a strong dollar and a hawkish Fed. However, their current account positions have improved, and this boosted their resilience (Exhibit 1). This also allows them more flexibility in setting monetary policy. In fact, Bank Indonesia (BI) has agreed with the government for a third round of burden-sharing scheme. BI would buy USD 30billion worth of government bonds in 2021 and 2022 to fund COVID-19 healthcare and social support.
EXHIBIT 1: CURRENT ACCOUNT POSITIONS, CURRENCY MOVEMENTS AND RESERVE ADEQUACY
Overall, the BoK is perhaps an exception in the region for downplaying the economic impact from the pandemic. Robust export performance from a strong demand for consumer electronics and components has been helpful. It is also right in paying attention to potential financial stability concerns relating to a prolonged period of low borrowing costs and ample liquidity globally. That said, other central banks in the region seem to prioritize addressing the pressure from the pandemic.
Asian investors are expected to still face very low cash rates at least for the next 12-18 months. Generating income to counter inflation and the erosion of purchasing power continues to be essential.
With the Fed possibly starting to cut back bond buying later in the year, the risk to U.S. government bond yields is on the upside. With most Asian central banks keeping to their current policy position, this could give the U.S. dollar a temporary advantage over Asian currencies. Hence, Asian investors would need to consider currency risks when it comes to the international portion of their portfolio with the U.S. dollar strengthening.
China’s reversal of monetary policy could benefit its fixed income market. While many investors are concerned about the default risk of property developers, this can be managed with active selection and investing in a broad set of companies for diversification purpose.