Asian central banks face policy dilemma from Fed rate-cut delay, FX crunch

As the U.S. Federal Reserve holds off on its own rate cuts and Asian currencies come under pressure, central banks in Asia face a dilemma. Lowering before the Fed does risks adding pressure to already-weak Asian currencies, pushing up prices of imported goods and services and sending inflation rates higher.

Delaying the long-awaited start of easing risks hobbling the pace of economic recovery, with high borrowing costs potentially curbing domestic demand and posing a particular threat in countries with high levels of household debt, like Thailand.

With the U.S. economy proving more resilient than anticipated, and inflation slower to cool, Fed officials have indicated that rates are unlikely to fall as early or by as much as they had previously expected this year.

That prompts some economists and analysts to dial back expectations of the rate-cutting cycle in Asia.

“Asian central banks would not cut ahead of the Fed," Morgan Stanley economists said in a recent report, adding that they now see a shallower easing cycle in Asia starting around August once the Fed starts unwinding.

The Fed’s policy path is typically seen as a key factor for Asian counterparts, particularly those whose economies are sensitive to foreign-exchange rates. Markets pricing in a more hawkish Fed rate path also firms up the dollar, which could get even more support from haven flows if concerns about the conflict in the Middle East intensify.

“High U.S. rates will keep Asian central banks concerned about the effects of potential currency weakness on inflation staying durably within target," Morgan Stanley economists led by Chetan Ahya said in the report.

While in some countries like Australia and India, rate cuts may have been delayed anyway as inflation isn’t yet under control, other central banks are waiting keenly for a rate cut from the Fed, said Pramod Shenoi, head of APAC research at CreditSights.

“Higher rates for longer slows economic activity and also leads to increasing distress for individuals and companies that are leveraged. But cutting ahead of the Fed risks currency volatility which most central banks don’t want to see happening," Shenoi told Dow Jones Newswires.

Sharp drops in the yen, yuan and won have been furrowing brows among policymakers. China’s central bank has reiterated its commitment to stabilizing the yuan, while finance ministers from Japan and South Korea voiced “serious concerns" over their currencies’ weakness. Officials in Malaysia and Indonesia have also stepped in recently to defend their respective currencies.

The rupiah’s slump versus the dollar was a main factor behind Bank Indonesia’s surprise move to hike rates on Wednesday, which the bank’s governor said was a pre-emptive step to strengthen the currency’s stability and cushion against the impact of worsening global risks.

To what extent rate-cut delays could affect economies varies. For more export-oriented countries, much depends on the strength of external demand, according to the Morgan Stanley report. For more domestic-facing economies, it is about the strength of demand at home.

The acceleration of Asia’s exports in the past three months could help the region manage the potential downside to growth from central banks having to maintain higher real rates, MS said.

Denise Cheok, assistant director and economist at Moody’s Analytics, points out that while most central banks in Asia have rates above prepandemic levels, they don’t appear high enough to significantly weigh down household spending.

“The domestic economy remains fairly robust for most countries, especially in Southeast Asia," she told Dow Jones Newswires. “Rate hikes in 2022 were also fairly moderate in Asia, compared with central banks in other parts of the world."

While many central banks’ focus has largely been on taming the postpandemic surge in inflation, keeping rates too high for too long could push the needle back too far in the other direction.

If interest rates stay high, there is risk that domestic demand will be curtailed by a larger extent than necessary to bring inflation in check, said Alex Muscatelli, director, economics group at Fitch Ratings.

Lower spending by households and companies could in turn affect labor markets, ultimately leading to widespread downward pressures on prices beyond central banks’ objectives, he told Dow Jones Newswires.

“At the same time, cutting rates too early could lead to inflation expectations and price pressures remaining at levels which are too high—and a strong U.S. dollar due to expectations of a shallower easing cycle by the Fed would exacerbate this further," Muscatelli said.

A spike in oil prices spurred by renewed Middle East uncertainties could further complicate things.

If the situation in the Middle East escalates, the recent moderation in energy markets will quickly reverse, pushing up inflation expectations and stalling Fed rate cuts, Moody’s Analytics said.

“This, in turn, would push back the timing of rate cuts in Asia as well," Cheok said.

—Ying Xian Wong contributed to this report

Write to Fabiana Negrin Ochoa at fabiana.negrinochoa@wsj.com