A food stall in Gwangjang Market in Seoul as South Korea’s central bank is seen to be among the first in the region to cut its benchmark interest rate.
Francois Lochon | Gamma-rapho | Getty Images
Central banks in Asia could start cutting rates earlier than the Federal Reserve, economists at Nomura predicted.
A dovish pivot from major economies in the region ahead of the U.S. central bank — or “decoupling” from a global tightening cycle led by the Fed — could take place due to different macroeconomic conditions in Asia, economists led by Sonal Varma wrote in a Friday note.
“Our view of Asian central banks cutting policy rates ahead of the Fed in this cycle is based on the fundamental divergences between Asian and U.S. economies,” Nomura economists wrote.
Minutes from the Federal Reserve’s June meeting showed there will be more rate hikes ahead, albeit at a slower pace. On the contrary, China has turned to policy rate cuts as its economic recovery from Covid lockdowns continues to sputter and investors eye further stimulus measures to follow.
According to a real-time survey conducted by Nomura’s research team, more than 32% of respondents said they expect South Korea’s central bank to be the first to cut rates after China, followed by Indonesia, the Philippines, then India.
“After China, Korea, India and even Indonesia could cut rates ahead of the Fed, due to faster disinflation, weak demand and higher real rates,” the economists wrote.
Faster disinflation a concern
The Nomura economists pointed to a downturn in goods-led manufacturing hurting growth in the region and disinflation as the main reasons why they expect Asian central banks to cut rates before the Fed.
“The region is now also entering a period in which domestic demand is likely to slow, in our view, reflecting the lagged effects of monetary policy normalisation,” they wrote.
“As domestic demand cools and core inflation falls durably, this will call for moving rates to less restrictive settings, in our view,” Nomura economists said.
They added that tighter conditions in the labor market, unlike the U.S., are “not a concern for Asia,” except for Singapore.
“So core inflation is not as sticky,” they wrote, adding that inflation in Asia has been driven more by supply than demand.
China’s producer prices have already entered deflation territory, while South Korea’s inflation hovered around 2.7%, nearing its central bank’s target.
“Disinflation is progressing much faster in the region, especially in EM (Emerging Markets) Asia, where food and energy have higher weightings in the CPI basket and the inflation surge was more supply-side driven,” the economists wrote.
Seoul could start cuts
Nomura expects the Bank of Korea to be one of the first central banks after China to cut rates. Economists expect it to cut its benchmark interest rate by 25 basis points in October and an additional 25-basis-point cut by the end of the year.
“The BOK has increased emphasis on domestic factors (growth) even though it appears to remain sensitive to the Fed’s policy stance,” the economists wrote.
They pointed to the central bank’s governor Rhee Chang-yong shrugging off investor concerns about a weakening South Korean currency. Rhee told CNBC in May that talk of rate cuts would be “premature.”
Nomura economists wrote, “Governor Rhee clearly stated that interest differentials is not a key driver for KRW weakness, and dismissed risk of financial events due to currency weakness.”
The Korean won traded at 1,298.57 against the U.S. dollar on Tuesday morning as investors looked ahead to the central bank’s monetary policy decision slated for later in the week.
India has history
Economists at Nomura also pointed to India’s domestic-driven economy, which could support a monetary policy trajectory that is independent from that of the U.S. Federal Reserve.
“The [Reserve Bank of India’s] policy is primarily driven by domestic factors and if they warrant policy easing (due to lower growth and inflation), then the RBI can move ahead of the Fed,” the economists wrote.
Nomura expects the Reserve Bank of India to start cutting rates in October as well, with a total cut of 75 basis points predicted.
“Our judgement is that, as India’s growth begins to disappoint, the RBI’s flexible inflation targeting regime will mean placing more of an emphasis on growth, as long as underlying inflation is aligning closer to 4.5%, which is already the case,” they wrote.
The firm noted that India has previously decoupled from the Fed’s cycle. The Reserve Bank of India started cutting rates in February 2019, months before the Federal Reserve made its first rate cut in decades.
“This runs counter to the widely held view that monetary policy in high yielding/current account deficit countries is aligned to the Fed due to FX concerns,” the economists wrote.