Singapore: Weaker global demand may slow Asia’s exports next year but analysts say that won’t depress Asian currencies, which will be pushed up by capital inflows spurred by healthy economic growth and the existence of lower US interest rates.

Most Asian currencies have retreated since the start of the month as foreigners sold local stocks, led by a 3% slide in the South Korean won, but analysts say the region still offers attractive returns, so foreign money will return.

“So long as the US economy does not slip into recession, Asian currencies should still appreciate as they will still be attractive in relative growth terms," said Claudio Piron, senior currency strategist at JPMorgan Chase & Co.

Being careful: The People’s Bank of China in Beijing. The fall in US interest rates has limited the scope for China’s central bank to raise interest rates further since that could spur capital inflows and feed inflation.

The US Federal Reserve cut its main interest rate by 0.25 percentage point in October, after a half-point cut in September. Citigroup Inc. economist Yiping Huang said the Fed was likely to cut the fed funds rate by another point in coming months, widening the differential with Asian countries, which have mostly left rates unchanged despite the global financial turmoil. The US fed funds rate of 4.5% compares with official rates of 8.25% in Indonesia, 7.75% in India, 5.5% in the Philippines, and 5% in South Korea.

If anything, rising inflation in countries from China to Singapore could lead Asian authorities to tighten monetary policy, and not just by raising interest rates, analysts said.

“I would say that higher inflation due to surging commodity prices is creating greater incentives for Asian central banks to accommodate stronger currencies," said Mirza Baig, a currency strategist at Deutsche Bank AG.

Many analysts expect the gradual appreciation in the Chinese yuan to pick up pace next year amid signs that Chinese leaders are willing to use a stronger currency to fight inflationary pressure. The fall in US interest rates has limited the scope for China’s central bank to raise interest rates further, since that could spur capital inflows and feed inflation.

“A further (yuan) appreciation will also give additional confidence to other regional monetary authorities to allow gains in their own currencies," Patrick Bennett, Asia currency and rate strategist at Societe Generale Group, said in a research note.

Sean Callow, a currency strategist at Westpac Banking Corp. ABN, said the yuan’s rise would in particular support the Singapore dollar and Malaysian ringgit, seen as yuan proxies. Because the Singapore dollar is allowed to trade within a trade-weighted band in which the yuan figures prominently, it is viewed as low-risk but correlated with the yuan. Neighbouring Malaysia’s ringgit follows the Singapore dollar closely. Citigroup analysts expect the Indian rupee and the Philippine peso—the region’s top performers this year, to match the yuan’s gains in 2008, but the South Korean won and Taiwan dollar could lag behind.

The yuan has gained about 5.7% against the dollar so far this year, but analysts expect an acceleration to perhaps 7% or 8% in 2008. The rupee has gained around 13% against the dollar this year. It hovered near 6.72 to the dollar in one-year offshore non-deliverable forwards on Thursday, implying a rise of more than 9.5% in the next 12 months.

Powered by China and India, Asia is on track to grow about 8% annually in the next two years, while US growth is expected to slow to 2-2.5%, Citigroup’s Huang said.