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Asia strikes out on different rate path from Fed

BEIJING: It stops short of a declaration of monetary independence, but Thursday’s surprise South Korean interest rate cut underscores just how much Asia has managed to free itself from the US interest rate cycle.

Even if South Korea will probably be the only country to lower borrowing costs, because its domestic demand is much weaker than its neighbours’, few are likely to march in lockstep with the Federal Reserve as it ratchets up rates, economists said.

“I don’t think Korea is necessarily going to set a template, but it certainly is an encouraging sign that Asia is trying to deal with its own economic agenda more independently of what’s going on with the US,” said Sun Bae Kim, chief Asia economist for Goldman Sachs in Hong Kong.

Indeed, despite Hong Kong’s dollar peg, the territory’s banks signally failed on Wednesday to increase lending rates after the US central bank raised its policy rate by a quarter-point to 1.50 percent, the second in this series of tightenings.

But is this monetary autonomy a sign of strength or weakness?

To be sure, a combination of belt-tightening and export growth driven by deliberate currency undervaluation has enabled Asia, including Japan, to build up fat current account surpluses and a $2.19 trillion stockpile of reserves.

As a result, policy makers no longer need to pad faithfully behind the Fed, fearing a debilitating run on their currencies if their interest rates do not match up to the United States’.

But economists said this leeway on interest rates — a stark contrast from the last major US tightening cycle in 1994-95 — also reflected sub-par domestic economic performance. Investment is well below pre-crisis levels, bank lending is still weak — a reason why Hong Kong banks stood pat — and inflation, though rising, generally remains low.

Dominique Dwor-Frecaut of Barclays Capital in Singapore said Asian economies risked discovering yet again that, as export orders ebbed, domestic demand would not take up the slack because post-crisis corporate and financial reforms were incomplete.

“They’ve done a lot on the external side. But their domestic economies are not as lively as they could be because they haven’t done the hard work of restructuring,” she said.

Dwor-Frecaut had forecast that South Korea would cut rates in September but she does not expect other countries to follow suit. Instead, she said, they were likely to respond to any weakening of demand by keeping their currencies cheap.

Creeping inflation: Inflation is picking up across Asia. Headline prices in Thailand in July rose at their fastest clip since February 1999. The spike in Taiwan inflation was the largest in six years.

But Jim Walker, chief Asia economist at brokers CLSA in Hong Kong, said he was not worried that central banks were falling behind the curve as there was only scattered evidence that higher food and oil costs were passing through to core consumer prices.

“More than anything, these are deflationary elements, especially on the energy side, in Asia because they increase countries’ import bills and reduce their ability to buy domestically. And that brings economic activity down,” he said.

Walker said he would worry that monetary policy was too loose only if rising oil and food costs started to translate into higher wages.

But he said there was no cause for China, for instance, to respond to the acceleration in its inflation rate to 5.3 percent in the year to July, reported on Thursday, because it was due entirely to surging food prices.

“There’s much more scope for Asian economies to withstand US interest rate increases or indeed to go against them as Korea has just done,” said Walker.

He expects only Thailand, which is enjoying robust domestic growth, to match the Fed, though the Philippines and Indonesia remain vulnerable. Economists said the classic policy prescription for South Korea, facing a dearth of domestic demand caused by the bursting of a credit bubble, would be to relax fiscal and monetary policy and let the won rise to curb any resulting inflationary pressure.

“Today’s move is a very encouraging sign of a step in that direction,” Kim at Goldman said. Sharon Lam and Andy Xie at Morgan Stanley also congratulated the central bank for not raising rates to dampen inflation.

“While the expansionary monetary policy cannot turn around the structural weaknesses of the economy, it serves as a confidence boost that the government is acting proactively to smooth the cyclical frustrations,” they said in a note. reuters

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