SINGAPORE (BLOOMBERG) - China's decision to weaken its currency on Monday (Aug 5) amid an escalating trade war will put Asian central banks on the defensive as they gauge how much monetary-policy easing their economies can withstand.
The yuan broke through 7 to the US dollar on Monday after the People's Bank of China set its daily reference rate weaker than 6.9 for the first time since December. That pulled down Asian currencies from South Korea to Thailand and worsened a sell-off in stocks.
The market turmoil may give Asian policy makers reason to pause just as the US Federal Reserve's rate cut last week gave them space to pursue looser policy. New Zealand, India and the Philippines are still likely to proceed with their rate cuts this week, but future policy action across the region will become more uncertain.
"It is obvious that this move makes it harder for regional monetary authorities to lower their interest rates," said Mr Toru Nishihama, emerging-market economist at Dai-ichi Life Research Institute in Tokyo. "The regional central banks have to be more cautious across Asia as a rate cut under this environment would add to downward pressure on their currency."
Here's how Asian officials have responded so far to China's move and what analysts are watching out for:
South Korea is mired in its own tit-for-tat trade tensions with Japan, and is one of the most exposed economies to China's export woes, complicating the Bank of Korea's job. The three-year bond yield fell to a record low on Monday as traders speculated that the central bank could cut rates faster than currently projected. But currency fluctuations, limited policy space and high consumer debt levels may keep policy makers on guard.
"They don't really have a lot of room, so I think they'll continue to monitor how things play out before deciding" on further interest-rate cuts, Mr Khoon Goh, head of Asia research at Australia & New Zealand Banking Group in Singapore, said of the weakening yuan's impact on the Bank of Korea. "This is going to be the balancing act that central banks in the region will need to weigh out."
South Korea's won extended a decline to a three-year low on Monday after breaching the key 1,200 support level. South Korea's foreign exchange authority called Monday's moves "excessive" and "abnormal."
After spending much of 2018 beholden to a weakening rupiah that prompted 175 basis points of rate hikes, Bank Indonesia now faces a tougher decision as it unwinds some of that tightening. The result could be a slower pace of rate cuts than in past cycles.
The latest escalation in trade tensions "validates our view that its rate-cutting cycle will be more calibrated than in the past as Bank Indonesia navigates and treads these external risks cautiously," said Mr Euben Paracuelles, an economist at Nomura Holdings Inc in Singapore. He said a second rate cut from Bank Indonesia this month after last month's easing "is unlikely".
Economists are sticking to their calls for a rate cut by Bangko Sentral ng Pilipinas on Thursday (Aug 8) despite the peso's depreciation against the US dollar following the PBOC's move. The currency is still up 1.6 per cent against the greenback this year.
Policy makers in the Philippines are more likely to remain focused on slowing inflation and weaker economic growth that will tip them to cut the benchmark interest rate this week, possibly even as much as 50 basis points, said Mr Nicholas Mapa, senior economist at ING in Manila.
The Bank of Thailand has been struggling to contain a surge in the baht, seen as a safe haven currency among emerging markets. The central bank has already taken steps to curb the currency, while remaining hesitant to cut rates for now. Just two of 27 economists in a Bloomberg survey ahead of Wednesday's decision predict a cut.
The central bank should "take care" of baht strength, Industry Minister Suriya Juangroongruangkit said on Monday at a conference in Bangkok, noting that the currency's rise has been hurting competitiveness.
A stronger yen will further frustrate Bank of Japan governor Haruhiko Kuroda's already tough job of stoking inflation by lowering import prices and cutting into corporate profits. Mr Kuroda last week pledged to act before any risks to the 2 per cent inflation target materialise, but many BOJ watchers are sceptical that the central bank has sufficient firepower left after more than six years of extraordinary monetary stimulus.