The worsening Middle East crisis has significantly altered the perspective for Asian central banks, as the severe supply shock creates a challenging balance between supporting economic growth and controlling inflation.
For emerging Asian central banks, cutting interest rates has become a risky bet not just because of the added price pressure from higher fuel costs, but the risk of triggering capital outflows through worsening terms of trade with the U.S.
Policy Dilemmas Across Asia
The Reserve Bank of India, for one, expects to focus more on supporting growth by keeping interest rates low, according to sources. But a rush towards the safe-haven dollar, which is intensifying from the U.S.-Iran war, may force it to ramp up intervention to prop up its weakening currency.
Thailand and the Philippines may be forced to reverse their dovish monetary policy stance, even as rising fuel costs hurt their economies, said Toru Nishihama, chief emerging market economist at Dai-ichi Life Research Institute in Tokyo.
Share markets plunged and the safe-haven U.S. dollar rose in Asia on Monday as oil surged past $110 a barrel, stoking fears of a protracted Middle East war on global energy supplies and higher inflation that may force central banks to hike rates.
The trade-off is particularly acute for manufacturing-heavy economies like South Korea and Japan, which are dependent on global trade, stable markets and cheap raw material costs – all being undermined by the widening Middle East crisis.
South Korea’s central bank, which kept rates steady in February, could take a more hawkish stance if inflation persistently stays a percentage point above its target, said Citigroup economist Kim Jin-wook.
Global Implications
Developed market central banks, such as the Federal Reserve, also face a tricky act balancing growth, inflation and increasing political pressure.
The dilemma runs deep for the Bank of Japan. If crude oil prices stay at $110 for a year, that could knock 0.39 of a percentage point off growth, according to Nomura Research Institute, a huge blow to an economy with subdued potential growth of around 0.5% to 1%.
But unlike in the past when it could afford to pause rate hikes, the BOJ has less room now to look through price pressures with inflation having exceeded its 2% target for nearly four years.
Australia and New Zealand are typical of how economies in different cycles put policymakers in a difficult bind.
Sustained oil price hikes risk de-anchoring price expectations in Australia, where inflation is already elevated, said Jonathan Kearns, chief economist at Challenger who is also a former Reserve Bank of Australia official.
New Zealand faces a different challenge as the economy has struggled to recover from the hit from past rate hikes.
International Monetary Fund Managing Director Kristalina Georgieva said on Monday a 10% rise in oil prices, if persistent through most of the year, would result in a 40-basis-point increase in global inflation.
(With inputs from Reuters)
