Fed move seen to pressure peso

The Bangko Sentral ng Pilipinas will likely intervene more to cap the local currency’s appreciation against the US dollar as cash flows to emerging markets may intensify with the US Federal Reserve’s vow to keep interest rates at near-zero levels, global banking giant Citigroup said.

In a commentary dated January 31, Citi Asia-Pacific economist Johanna Chua said the central banks of the Philippines and Taiwan would have room to cut key interest rates “given still positive real rates, muted inflation risks, and a desire to dissuade FX (foreign exchange) appreciation.”

The BSP, for its part, is expected to slash its key interest rates by another 25 basis points within the year, after an initial 25-bp cut in January.

The US Fed turned more “dovish” than expected by the markets when it stated that interest rates would stay low until at least late 2014, stretching the projected timeframe from an earlier pronouncement of mid-2013.

Asia’s initial policy response is to tolerate, even welcome, foreign exchange appreciation especially in the case of India.

But Chua noted that foreign exchange intervention could soon re-emerge for some markets given growth concerns.

“We think external competitiveness considerations will likely be the bigger factor weighing on FX intervention motives than the desire for precautionary reserve accumulation. Looking at various indicators, we think Taiwan, the Philippines, Korea, and possibly Malaysia, have the stronger incentive to intervene earlier relative to others,” she said.

In the case of the Philippines, underperforming exports were cited as a potential trigger for the BSP to cap local currency appreciation.

But while slashing interest rates is another way to temper local currency appreciation, Chua thinks that most central banks in the region have limited room to cut rates much further, except India.

“Outside of India, real rates remain historically low and liquidity ample. Our monetary conditions measure still looks historically accommodative. Potential impact of global liquidity on commodity prices likely leads CBs to err on the prudent side…. Moreover, fiscal policy will likely be the preferred counter-cyclical policy tool for many,” she said.

If capital inflows persist strongly, India could cut by more than our 100-bps base case in 2012, given high real rates and inflation relief from FX stability. The Philippines and Taiwan are potential candidates too, she said.