A surge in the US dollar has set Asian currencies on course for their worst quarter since the 1997 financial crisis and created a dilemma for central bankers.
Policymakers already grappling with the fastest inflation in decades now face stark choices: forcefully raise borrowing costs to defend currencies and risk hurting growth, spend reserves that took years to build to intervene in foreign exchange markets or simply step away and let the market run its course.
The Bloomberg JPMorgan Asia Dollar Index is poised for a 4.8 percent drop this quarter, the steepest since the crisis pummeled currencies almost 25 years ago.
Central banks in the region have lagged emerging-market peers in raising rates as they seek to boost recovery after the COVID-19 pandemic
That more patient policy stance is weighing on their currencies as the US Federal Reserve pushes ahead with big hikes.
“Central banks are thrust into a difficult position to tighten, even as the recovery from the pandemic is not yet complete and with the specter of a US recession ahead,” said Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore. “Complicating the picture is the strong greenback, which adds to the pressure to tighten as weak currencies exacerbate imported inflation.”
The South Korean won is set for its largest monthly decline in 11 years, while the Philippine peso is headed for its worst quarter in 14 years.
The Reserve Bank of India is fighting on several fronts to slow the rupee’s decline to fresh records.
In Japan, the yen, which is not part of the index, has lost 11 percent of its value against the US dollar since the end of March amid a growing yield differential with the US as the Bank of Japan sticks to its ultra-easy monetary policy.
However, Asia’s central banks might have to change tack as consumer prices steadily rise and weaker currencies add to concerns about imported inflation.
The Bangko Sentral ng Pilipinas has said it would consider larger rate increases after two quarter-point moves, while the Bank of Korea has kept the door open for a larger-than-usual hike this month.
“Inflation is proving to be persistent, and central banks may have to move ahead of schedule and be even more aggressive than expected,” said Eddie Cheung (張敬勤), senior emerging-markets strategist at Credit Agricole CIB in Hong Kong. “Growth is still holding up for the time being and that gives them leeway to focus on fighting inflation.”
Currency depreciation could cause regional central banks to tighten “if it adds to import-led inflation on top of the supply-side inflation already seen,” Morgan Stanley economists led by Deyi Tan wrote in a report published on Sunday.
The analysts expect rate hikes to continue on surging inflation expectations.
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