Why Taiwan's government is unlikely to cut rates

Interest rates are already at ultra-low levels.

According to DBS, Taiwan’s central bank (CBC) will hold the 2Q monetary policy meeting this Thursday. DBS expects no policy change at this meeting. Compared with one quarter ago, the government has cut the 2013 GDP growth forecast to 2.4% from 3.6%, and lowered the inflation estimate to 1.2% from 1.4%. 

Despite the forecast downgrade, the central bank may refrain from cutting rates to boost the economy.

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Interest rates are already at ultra-low levels. Due to abundant liquidity and cheap financing costs in the domestic financial system, property prices have surged as much as 50% over the past four years, and their growth rate remained strong at about 10% YoY in 2Q13.

As such, we think the CBC will need to balance between the goals of bolstering economic growth and stabilizing prices / safeguarding financial stability. Staying put will be the best policy option.

We don’t expect the CBC to react to the short-term market volatility triggered by the fear of Fed’s QE reduction. The volatility in Taiwan’s equity, bond and FX markets was not too high if compared to emerging markets in Southeast Asia.

As Taiwan didn’t receive large size of capital inflows during the previous QE episodes, the current risk of capital reversal should also be relatively low. The CBC this week is likely to emphasize that domestic liquidity conditions remain accommodative and the TWD is less volatile than other emerging Asian currencies.

In the longer term, a change in the Fed’s monetary policy will have significant implications for Taiwan. The historical correlation between Taiwan’s and US’s interest rate cycle (and economic cycle) was high, reflecting the procyclical nature of Taiwan’s exports and the large trade exposure to US market.

If the Fed is correct that US recovery will gather pace in 2014-2015 and conditions will allow for a withdrawal of QE, Taiwan’s economic growth could also pick up in the next 1-2 years and the CBC may begin to normalize domestic monetary policy accordingly.

In our long-term forecast, we expect rate hikes by the CBC staring from the first half of 2014.