Be careful what you wish for: Why a Fed cut makes life easier and harder for Asian central banks

FOR much of this year, many emerging Asian economies have found themselves forced to hold an unwelcome course on interest-rate policy that has become more outdated by the day.

The reason is simple. The US Federal Reserve began its post-Covid tightening cycle back in March 2022, gradually increasing the top end of its Fed funds target rate range from a pandemic-era 0.25 per cent to 5.5 per cent, where it has sat since the middle of 2023. Because of that, Asia’s central banks have been caught in a double bind.

On the one hand, their own inflationary pressures have eased significantly, in many cases faster than those in the US. These days, they are worrying more about stifling growth by keeping rates too high for too long.

On the other hand, the Fed’s higher-for-longer policy has prevented Asian rate-setters from lowering their own policy rates, for fear of hurting their currencies by worsening interest-rate differentials that are already uncomfortably narrow or even negative.

Interest rates in China, South Korea, Malaysia and Thailand have now been lower than in the US for nearly two years, while the positive differential is historically tight in India, Indonesia and the Philippines.

When it comes to policy-rate movements, China has been the region’s outlier for some time, unsurprisingly due to its housing market correction that started in 2021. Its central bank most recently cut rates by 20 basis points in July, seeking to address weakening domestic demand.

But among emerging Asia’s central banks, only the Philippines’ has so far actually changed direction on rates, when it shaved a quarter-point in August 2024 from the 6.5 per cent that it had maintained since October 2023.

But now, in theory, everything can change. With Fed chair Jerome Powell indicating at Jackson Hole on Aug 23 that the US central bank will, as expected, cut rates at its next meeting on Sep 17-18, his Asian counterparts at last have the cover they need to follow suit. At J Safra Sarasin, our assumption is that they will all do so before the end of the year.

Asian currencies have recently begun to reflect this changed sentiment. The long-awaited weakening of the US dollar has meant that countries including Indonesia, Malaysia, the Philippines, South Korea and Thailand have all seen their currencies appreciate sharply in recent weeks – some are touching levels seen at end-2022, when interest rates for many were still on the way up.

Competing priorities

For Asia central bankers keen to have the wiggle room to switch policy, any downward move by the Fed is obviously good news. Broadly, inflation in the region is no longer the concern that it once was. According to the most recent indicators, core inflation in India was below 3.4 per cent. In the Philippines it was 2.9 per cent, while South Korea, Indonesia and Malaysia are all at around 2 per cent. Thailand’s most recent print has ticked up, but is still only about 0.5 per cent.

But how exactly central banks will respond to their newfound room to manoeuvre, and at what speed, will be determined by their domestic concerns. Some still have to weigh up issues of financial stability, which have tended to support a higher rate policy. Others have particular sensitivities that they must accommodate. None has an easy decision to make.

China has a number of other levers beyond policy rates that it can pull. Therefore, it is unlikely to keep cutting its rate much beyond perhaps another 10 basis points this year.

Besides a step-up in Chinese government bond issuance and allowing for its proceeds to be used more broadly, media reports suggest that the Chinese government is considering allowing homeowners to refinance their mortgages. If this comes true, it could help support consumption.

The Philippine central bank, which had already got ahead of the Fed with its August cut, could be one of the more aggressive in the months to come, perhaps cutting by 25 basis points at each of its October and December meetings.

India, meanwhile, is a good illustration of the competing priorities the region’s central banks face. Core inflation there is the lowest it has been for 10 years, and softening GDP also points to a slowdown. But food inflation has recently spiked, and although this ought to be tempered by recent rainfall, the Reserve Bank of India could well move later than some of its neighbours.

In Malaysia, while the rate of inflation has behaved well, the central bank is concerned that one recent change on the fiscal front – the removal of the diesel subsidy in June – could lead to higher inflation in the coming months. Also, as growth remains robust, Bank Negara Malaysia is likely to be the only one to hold its policy rate through the end of the year.

A balancing act

Indonesia’s central bank – with its explicit dual mandate for currency and price stability – has one of the trickier paths to tread. Even though the rupiah has recently erased its 2024 losses, the country is very dependent on external funding, making any currency weakness a particular headache.

On top of that, a slight fall in growth is hardly a concern yet, and so a case could be made for waiting to cut rates until the currency has enjoyed a longer period of strength – although still before the end of the year.

Financial stability has been the issue for South Korea and Thailand, the central banks of which have cited it as a driver for keeping rates high. But with currency pressures now easing, it’s likely that maintaining growth will become the priority for both, which would play in favour of a cut.

The balancing act that all these central banks must perform is a reminder that even when something has long been wished for, the correct response when it comes true may not be obvious – or easy.

Yes, a Fed move frees Asia’s central banks to respond if they wish, but the picture is more complicated than that. After a long period of forced policy, the freedom to act will bring a new kind of pressure.

The writer is emerging markets economist at J Safra Sarasin, a private bank