Taiwan central bank fine tunes monetary policy

There is pressure for Taiwan's central bank to ease policy to support economic growth, says DBS.

DBS Group Research noted:

Following the rate cuts in China and Korea over the past two weeks, expectations are building up in Taiwan's financial markets that a local rate cut will follow suit soon.

There is indeed pressure for Taiwan's central bank (CBC) to ease policy to support economic growth. Real GDP registered a mere growth of 0.4% YoY in 1Q, and will likely stay at this level in 2Q. Chances are high that the official growth forecast for 2012 will be downgraded significantly when the 2Q GDP is released on July 31. Sentiment will sour.

Cutting rates can help support sentiment, reduce interest burdens on local borrowers and thus underpin domestic demand. Cutting rates is also a way to help weaken the Taiwan dollar so as to support the competitiveness of exports.

On the other hand, however, there are also factors constraining the CBC from cutting rates. Unlike the inflation downtrend seen in China and Korea, inflation has continued to pick up in Taiwan. Headline CPI has risen to 1.7% YoY in 2Q from 1.3% in 1Q, and is expected to remain elevated above 1.5% in 3Q-4Q, higher than the long-term average of 1.0%.

The boosting effects on inflation resulting from the rises in energy and food prices will remain in place in 2H, given the arrival of the typhoon season in summer/autumn and another electricity price hike scheduled in the year end.

Admittedly, if the underlying demand is persistently weak, the current inflation pressure caused by energy and food prices will turn out to be temporary. If policymakers are worried about the growth outlook in 2H12 and 2013, they would cut rates in a preemptive manner.

Still, there will be limited scope for the CBC to do so. Monetary conditions are already accommodative. Comparing the overnight interbank rate and the core inflation excluding all energy and food, the rate-inflation gap is 0% in Taiwan, versus more than 1% in Korea.

The central bank would focus on fine tuning of monetary policy, for now. The overnight interbank rate dropped 6bps since last Friday, as the central bank reduced the issuance of CDs/NCDs in open market operations. The overnight rate of 0.44%, as of yesterday, remained higher than the 0.40% level set in end-March, before the CBC started to guide rates higher in response to the fuel price hikes on April 1.

This means that the CBC is currently in the process of withdrawing the liquidity tightening measures adopted earlier this year, while it remains too early to conclude that policymakers have entirely shifted to an easing stance.