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Asian central banks set for holding pattern in 2021 with rates at record lows

After a turbulent start to 2020 sent interest rates to record lows, central banks across the Asia-Pacific broadly kept their monetary policies unchanged in the fourth quarter of 2020 and are set to keep them on hold this year as the COVID-19 narrative in the region shifts from containment to economic recovery.

Only three of the 12 central banks tracked by S&P Global Market Intelligence resorted to interest rate cuts in the fourth quarter of 2020 as positive developments on vaccines against the virus coincided with a resurgence of infections in the region. Most other banks kept their rates on hold following a series of reductions in the first half of the year, while the Bank of Japan has kept its short-term policy rate unchanged since 2016.

"We expect Asia-Pacific central banks to remain on hold through 2021 for the most part," Shaun Roache, chief economist for Asia-Pacific at S&P Global Ratings, told Market Intelligence by email.

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Two of the interest rate cuts in the quarter came from Southeast Asia, where both Bank Indonesia and the Bangko Sentral ng Pilipinas further reduced their policy rates by 25 basis points to fresh lows. The Indonesian central bank said its move aimed to accelerate the domestic economy's recovery and address projected low inflation, while its Philippine counterpart saw "enough policy space" for a reduction to support the country's economic recovery.

While central banks are largely set to sit tight in 2021, Roache said Indonesia and some other emerging markets could still see further monetary policy easing as real rates remain high, keeping inflation low. "However, more easing by [emerging markets] becomes difficult the further that U.S. Treasury yields rise and the dollar bounces as this could trigger capital outflows," he added.

Bank Indonesia has "more than ample space" to cut rates further in 2021 and could opt to do so early this year as inflation remains muted and economic growth remains in negative territory, Nicholas Mapa, senior economist at ING Research, said in a Dec. 17, 2020, note. Analysts at UOB Group also expect Bank Indonesia to ease in the first quarter as the economic outlook remains uncertain, but noted that such a move would likely be the last cut for the central bank.

Alternative tools

The third cut of the quarter came from the Pacific, where the Reserve Bank of Australia lowered its key interest rate to a new low of 0.1% and announced a A$100 billion government bond-buying program in a bid to boost job creation and support the country's economic recovery. Across the Tasman Sea, the Reserve Bank of New Zealand maintained its cash rate at 0.25% and unveiled a funding program for banks to lower borrowing costs.

The two central banks "have become more aggressive in their accommodation" in the wake of the COVID-19 crisis and are likely to extend this monetary policy stance this year, Russell Investments said in its 2021 global market outlook report. In New Zealand in particular, negative interest rates remain a possibility as the central bank has noted that banks in the country have been preparing for such a dip below zero.

Other central banks in the region have also deployed unorthodox monetary policy tools following the pandemic, with the Philippine and Indonesian central banks also being granted authority to purchase government bonds. With monetary policy rates at or approaching their floors, market observers believe that central banks will instead resort to alternative measures to stimulate their economies' recovery.

"We expect monetary policymakers to continue to rely on unconventional tools — such as [quantitative easing, targeted longer-term refinancing operations], and other liquidity and yield control measures — to convey easing and in some cases, facilitate government borrowing," said Priyanka Kishore, head of India and South East Asia economics at Oxford Economics. The Australian central bank recently pledged to keep the three-year government bond yield at around 0.1%, while the Bank of Japan has committed to keeping the 10-year yield at around zero for more than four years.

Any further policy easing could also just as likely come in the form of fiscal measures from Asian governments, taking some burden off the region's central banks, according to Ratings' Roache.

Stimulus risks

While governments will look to withdraw fiscal stimulus as their economies normalize and COVID-19 vaccines are rolled out at varying rates across Asia-Pacific, all central banks in the region will still have to keep policy extremely loose for a sustained period, Roache said. But keeping rates at record lows presents its own set of problems.

"Two challenges loom for central banks. First, how to deal with the financial stability side effects of very low interest rates, especially rising asset and house prices. Second, how to calibrate policies as governments start tightening their belts," Roache said.

"Premature stimulus withdrawal remains a key risk," he added.