Mon, Nov 21, 2005 - Page 10 News List

Interest rates to move upward, bank predicts

TIGHTENING The nation's central bank may increase the pace of rate rises next year to address inflation and narrow the gap with interest rates in the US

By Amber Chung  /  STAFF REPORTER

The nation's central bank will have to further tighten monetary policy next year to combat escalating inflation and a widening interest-rate spread between Taiwan and the US, Goldman Sachs predicted.

"We could see the CBC [central bank] start to revert back to 25 basis points [0.25 percentage points] per meeting next year to bring rates back to a more `neutral' level, and provide more buffers to future inflationary shocks in the longer term," Goldman Sachs economist Enoch Fung said in a research note released on Oct 31.

But before this happens, the economist expects the central bank to implement a mild upward adjustment of 12.5 basis points next month, on concern over weakening domestic demand, despite low real interest rates after deducting inflation.

Since October last year, the monetary authority has raised rates five times. Its initial hike of 0.25 percentage points, was followed by four slower-paced increases of 0.125 percentage points.

"Inflation may surprise on the upside," Fung said, adding that Goldman Sachs believes inflation may be accelerating more rapidly than the central bank expects.

Given that the headline inflation (the officially announced inflation rate) has risen about 3 percent in the first three quarters of this year, mainly boosted by higher food prices because of typhoons, this is expected to start filtering into core inflation, Fung said.

Additionally, an increase in domestic fuel prices could provide a large shock to domestic demand and inflation, Fungt said.

Energy pricing

The government's measures to contain oil prices through 25 percent tax relief on fuel products, mean that fuel and energy providers like Chinese Petroleum Corp (CPC, 中油) may raise fuel prices if global oil prices remain high, he said. A US$1 per barrel rise in crude oil prices translates into a US$2 billion loss to CPC annually, he said.

The Directorate General for Budget, Accounting and Statistics said last week that it expects the consumer price index to hit 2.23 percent this year, and drop to 1.52 percent next year, on stabilizing food and oil prices.

Meanwhile, the US Federal Reserve may continue to boost interest rates until the middle of next year, increasing its Fed Funds Rate to nearly 5 percent, a level higher than market expectations, Fung said.

Faster pace

The nation's central bank would need to increase the pace of its rate rises -- even after the US hikes are finished -- to avoid enlarging the interest-rate differential between the two countries, which would put pressure on Taiwan's currency and balance of payments, the economist said.

Central bank Governor Perng Fai-nan (彭淮南) told lawmakers last month that the monetary authority would gradually bring the nation's real interest rates, which are negative at the moment, back to normal levels.

Real interest rates are equivalent to interest rates minus inflation, or the CPI. Under negative real interest rates, people tend to invest more given the low cost of capital rather than saving money. This can boost assets prices and in turn trigger inflation.

Since the central bank has committed to bringing rates back to a neutral level, the current rediscount rate charged to commercial lenders, 2.125 percent, is far from the target level, Goldman Sachs said.

With a mild rate increase expected next month, the investment bank expects the nation's currency to remain weak in the near term, given a lack of catalysts and the wide gap in interest rates with the US.

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