Asian central banks are poised to find more room to ease monetary policy after the Federal Reserve reduced interest rates by a quarter percentage point on Wednesday. This strategic move, which brings the Fed's benchmark overnight lending rate to a range of 4%-4.25%, signals potential further reductions ahead. The decision, framed by Fed Chair Jerome Powell as a risk management cut rather than a direct response to a weakening economy, suggests that additional cuts may be likely later this year.
The Fed's recent actions may have helped narrow the gap between U.S. and Asian bond yields, alleviating concerns surrounding currency stability. This situation presents Asian economies, particularly those grappling with significant domestic challenges, with increased flexibility to lower their own interest rates. Peiqian Liu, an Asia economist at Fidelity International, notes that the overall policy stance across the region is likely to become more accommodative.
Several Asian central banks have already taken proactive steps to mitigate the impact of U.S. tariffs imposed by the Trump administration. For instance, the Bank of Korea cut its policy rate to an almost three-year low in May, while the Reserve Bank of Australia implemented rate cuts to a two-year low in August. Additionally, India’s central bank enacted a substantial cut of 50 basis points in June.
Despite these adjustments, significant differences will persist among Asian economies, driven by varying economic conditions. Liu points to factors such as domestic inflation and the aftereffects of exports that were rushed out prior to the implementation of U.S. tariffs. Export-dependent nations like Japan, South Korea, and Singapore demonstrated stronger-than-expected economic growth in the second quarter, with both Seoul and Singapore narrowly avoiding a technical recession.
As we approach the fourth quarter, several Asian central banks, including the Bank of Korea and the Reserve Bank of India, are anticipated to continue reducing rates. According to Betty Wang, lead economist at Oxford Economics, earlier worries about rapid currency depreciation have proven to be overstated. Instead, a weaker dollar has created additional opportunities for Asian central banks to ease monetary policy in response to rising growth concerns.
Chi Lo, a senior market strategist at BNP Paribas Asset Management, supports this perspective, highlighting that real interest rates across much of Asia remain above historical averages. This situation allows central banks the flexibility for further rate cuts. India stands out as a notable exception, posting robust economic growth over the past two quarters, driven primarily by domestic demand rather than exports. In light of weaker external demand and higher U.S. tariffs, India is likely to focus on bolstering domestic growth through additional policy easing, according to Liu.
In August, India's inflation climbed for the first time in ten months, reaching 2.07%, just above the lower limit of the Reserve Bank of India's 2%–6% target range. There is considerable potential for further policy easing to address growth headwinds if necessary.
While many Asian economies are moving toward easing monetary policy, two major players, China and Japan, are taking a different approach. Japan's central bank aims to raise rates as it seeks to normalize its monetary policy. Economists expect the Bank of Japan to maintain steady policy at its upcoming meeting, with potential hikes later in the year as inflation has consistently exceeded the BOJ's 2% target for over three years.
Similarly, China's central bank kept its short-term rate unchanged at 1.4% following the Fed's rate cut, balancing the need for economic stimulus with concerns over a potential stock market bubble reminiscent of the 2015 crash. As China's economy showed signs of fatigue in August, with export growth slowing and key indicators like retail sales and industrial output falling below economists' estimates, the Chinese yuan is expected to remain strong amid a declining dollar.
The offshore yuan has appreciated approximately 3% against the dollar this year, trading at 7.1083 on Thursday. Economists generally anticipate that the yuan will strengthen to 7 against the greenback by the end of the year as Beijing focuses on countering deflation and stimulating growth. The Fed's rate cut opens up new options for the People's Bank of China, with expectations that the country will pursue monetary easing in the medium term to address its domestic economic challenges.
