Asia’s Interest Rates: Lower For Longer?


From North to Southeast Asia and beyond, official interest rates are rapidly heading south, while U.S. rates appear headed north. For Asia’s central bankers, it is a battle against time to shore up economic defenses against deflation and potential capital flight before the U.S. Federal Reserve acts.

On March 12, the Bank of Korea (BOK) joined the easy money crowd by cutting official interest rates to a record low of 1.75 percent, responding to an economy that according to the central bank has been “falling short of the originally forecast growth path.”

Noting falling exports and sluggish domestic demand, the BOK said the “negative output gap” would continue “longer than had been anticipated,” with inflation at its slowest pace since 1999 due to falling oil prices.

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Commenting on the rate cut, ANZ Research said the statement’s tone was more “dovish” than previously, with prolonged low growth raising the specter of deflation.

“At this stage, we think the BOK will continue to keep [the] policy rate at 1.75 percent…[but] if growth momentum deteriorates significantly, we will review our current policy call promptly,” ANZ said. It said a weaker currency could alleviate the need for another rate cut, with BOK Governor Lee Ju-yeol describing the Korean won as overvalued.

The BOK already cut in January its 2015 growth forecast to 3.4 percent from 3.9 percent, and a further downgrade in April could spur additional fiscal stimulus to support growth.

In cutting rates, South Korea became more than the 20th central bank to ease policy in 2015, taking action ahead of the U.S. Federal Reserve’s long anticipated hike in interest rates, possibly as early as this month.

A day earlier, it was Thailand’s turn to ease monetary policy with the Bank of Thailand making the “unexpected” decision to cut official rates to 1.75 percent, a move tipped by only six of 22 economists surveyed by Bloomberg News.

“The surprise move suggests the economy is much weaker than expected,” Bangkok-based analyst Sasikorn Charoensuwan said. “While the reduction is positive for stocks and bonds, it is negative for the baht and there’s concern that lower rates may lead to more outflows as the U.S. is expected to raise rates.”

Thailand’s economy expanded at its slowest pace in three years in 2014, hit by a slowdown in its biggest trading partner, China, which is expected to cause a further downgrade in its growth forecast for 2015.

“The policy effectiveness may not be much, but the rate cut can help the economy when the other drivers are not fully functioning,” Bank of Thailand Assistant Governor Mathee Supapongse told reporters after the rates decision. “We should use the bullets that we have.”

Asia’s other central banks have also been busy firing bullets at deflation. On March 4, the Reserve Bank of India (RBI) cut interest rates for the second time this year, with its benchmark repurchase rate dropping to 7.5 percent amid a weakening economy and slower consumer prices.

The RBI said it expected inflation in January 2016 to fall “below” 6 percent, instead of its previous projection of “around” 6 percent, amid “not insignificant uncertainties” concerning the inflation outlook, such as oil and food prices.

Economists expect the RBI to continue cutting rates, with projections the official rate could drop near 7 percent by year-end to spur growth, aided by expanded fiscal spending. India’s central bank and government of Indian Prime Minister Narendra Modi have agreed on an inflation target for the fiscal year through March 2017 “and all subsequent years” of 4 percent, plus or minus 2 percent, in an attempt to control prices after posting Asia’s highest inflation rate in 2014.

Asia’s biggest economy, China cut official interest rates in February to prop up faltering growth and may do so again to counter deflationary conditions, according to ANZ Research. According to the Australian bank, Chinese consumer prices may fall to 1 percent in March while producer prices remain negative amid continued deleveraging in the manufacturing sector.

“The weak inflation profile suggests that further monetary policy easing will be needed to fight against rising deflation risk. However, although the [Chinese central bank] cut interest rates again in late February, the easing effort so far has been limited,” ANZ said.

It warned that “aggressive” easing would be needed to bolster an economy that could fall well below the official GDP growth target of 7 percent in the first quarter. Beijing is targeting consumer price inflation of 3 percent this year after a rise of only 2 percent in 2014, amid sluggish domestic demand.

In February, Australia also cut rates to a record low of 2.25 percent, and more may follow. While Reserve Bank of Australia Governor Glenn Stevens surprised many by not following up with another reduction at the latest policy board meeting in March, his official statement suggested further easing is only a matter of time amid soft growth and low inflation.

Official interest rates are already zero in Japan, Asia’s second-biggest economy, with Bank of Japan Governor Haruhiko Kuroda under pressure to conduct further quantitative easing to achieve the bank’s 2 percent inflation target.

‘Existential Crisis’

According to HSBC’s Frederic Neumann, Asia’s move to slash interest rates reveals the concern of its central bankers over the downward price trend.

“China is an obvious example where deflation pressures have taken hold, but if you look everywhere from Korea to Southeast Asia, inflation is coming off much more rapidly than expected,” he told the New York Times.

This “brings home the strength of the disinflationary force that’s gripping Asia…It’s relentless,” he added.

HSBC group chief economist Stephen King has warned that fighting deflation could prove even tougher than the battle against inflation in the 1970s, with major risks to social harmony.

“Taming deflation through monetary policy alone is likely to be a lot more difficult than taming inflation. Interest rates can rise into the stratosphere if necessary. However, they can only fall to zero – or to marginally negative levels – thanks to the existence of cash. Quantitative easing, meanwhile, may boost asset prices, lower the exchange rate and reduce the risks of immediate financial implosion; but, to date, it has not really succeeded in arresting the march towards a world of falling prices,” he argued in a March 6 report.

“With so few policymakers taking the threat of deflation particularly seriously – and with so many of them convinced that economic recovery lies just around the corner – the risk is that we sink further into the deflationary mire thanks to weak monetary growth, high levels of debt and persistent deleveraging.

“Should recent deflationary trends continue – all the more likely as central banks take it in turns to play deflationary ‘pass the parcel’ via currency devaluation – policymakers may be faced with an existential crisis every bit as big as they went through in the inflationary 1970s.”

Meanwhile, the divergence between East and West on interest rates appears set to continue widening in 2015. Winning the battle against deflation while keeping a close eye on the Fed will keep Asia’s central bankers preoccupied for some time to come.

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