High inflation and low GDP growth worsens outlook in Taiwan

Hikes in fuel and electricity prices led to a CPI of 1.6%, throwing the Taiwan central bank at a tight juncture between low growth and high inflation.

Twin woes prevail as Taiwan's latest GDP growth remains at 3%, below the targeted 4%, and inflation falls 0.6% above the 1% average. The CBC is left with no choice but to keep the discount rate unchanged.

Here's more from the DBS Group Research:

Taiwan’s central bank is widely expected to leave the benchmark discount rate unchanged at 1.875% at today’s MPC meeting. Admittedly, growth is sluggish amid a fragile global environment. GDP growth of 2.8% QoQ saar in 1Q was well below the potential rate of 4%. The latest data for April-May suggested that growth has remained subpar at about 3% QoQ saar in 2Q, and will likely stay at this level in 3Q. Manufacturing PMI averaged 50.9 in the past two months, slipping from 51.9 in 1Q. May export orders, as a leading indicator for the export
outlook into early-3Q, rose a mere 0.2% MoM sa.

Weak growth should be accompanied by low inflation. However, due to the government’s recent hikes in fuel and electricity prices, as well as the rises in food prices amid the rainy weather, inflation has remained elevated. Headline CPI posted 1.6% YoY in April-May, above the long-term average of 1%. Core CPI excluding all food and energy rose 0.7% YoY in April-May, also higher than the trend rate of 0.4%.

Facing the dilemma of subpar growth and relatively high inflation, the best option for the CBC is to keep policy unchanged at the current juncture. In addition, thanks to the victory of the pro-bailout parties in Greek elections, the market worries about a Greek exit have eased. Foreign net investment in Taiwanese equities turned positive, rising US$ 0.4bn in the first two trading days this week. The Taiwan dollar is now hovering steadily against the US dollar at 29.9 after dropping 2% in May. The tentative stabilization in the financial markets should in turn, alleviate the pressures on the CBC to provide stimulus.

Further afield, the economy seems likely to return to the potential growth path from 4Q12 onwards on the back of a firmer global trend, the CBC should consider a resumption of interest rate normalization around the second quarter of 2013.