The central bank on Thursday announced that it would raise its three benchmark interest rates by 12.5 basis points as expected. This came on the same day that the US Federal Reserve’s second wave of quantitative easing, designed to kick-start the economy through bond purchases, expired.
Before the announcement, the central bank had increased interest rates by 62.5 basis points since June last year. Most economists now expect it to continue with the same pace of rate hikes until the end of this year or early next year.
The main reason behind the central bank’s decision to maintain its gradual interest rate increases was a desire to pre-empt inflation expectations driven by higher import material costs and help lift market rates to “normal levels,” according to the bank’s press statement and comments made by central bank governor Perng Fai-nan (彭淮南) on Thursday.
Indeed, in spite of concerns about external problems such as the eurozone sovereign debt crisis, the US’ slowing economic recovery and supply chain disruptions following Japan’s March 11 earthquake and tsunami, Perng said inflationary pressure could still increase further in the second half of the year, while a rate hike of only 12.5 basis points also suggested the central bank remains confident in the strength of Taiwan’s export-oriented economy.
In other words, no concern currently looms larger than inflation and therefore nothing is likely to persuade the central bank to stop its cycle of interest rate hikes. According to the Directorate-General of Budget, Accounting and Statistics’ latest forecast, Taiwan’s GDP growth is expected to slow to 4.58 percent in the second half of this year, after the 5.57 percent growth estimated for the first half of the year. At the same time, the consumer price index could increase 2.83 percent from a year ago, bringing full-year inflation to 2.1 percent.
While the central bank predicted on Thursday that the consumer price index for the whole year would increase less than 2 percent, the problem is that the bank’s mild pace of interest rate hikes lags behind the rising pace of commodity prices.
That in turn creates the problem of negative “real” interest rates — when nominal interest rates are lower than the rate of inflation — and there is unlikely to be a significant rise in local banks’ interest rates any time soon.
Negative “real” interest rates bring with them a number of implications. First, faced with an environment of very low interest rates, many people are hesitant to put their money in banks, preferring to look for alternative investment opportunities such as the real-estate and stock markets, thereby potentially contributing to the development of a bubble economy.
Second, in a cost-push inflation environment caused by rising food and energy prices, persistent negative real interest rates also indicate the continued erosion of household purchasing power and pose a threat to many of the nation’s wage earners who feel no benefit from the recovering economy because their salaries remain stagnant or rise only slightly.
Looking ahead, if cost-push inflation accelerates, the central bank might have to allow the New Taiwan dollar to appreciate more rather than rely solely on moderate interest rate hikes to stem price pressure. In the first half of this year, the strong NT dollar helped to offset the influence of rising imported commodity prices, though it remains to be seen how much the local currency will be able to appreciate further before compromising the nation’s export competitiveness.
Another challenge facing the central bank is what measures the Fed will adopt now that its program of quantitative easing has come to an end. The US central bank’s next move will certainly affect whether Taiwan continues its mild interest rate hikes or adopts more aggressive measures to slow inflation.
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