Growing problem in Asia: inflation. China’s inflation rate is near 4%, up from 1.5% last January, and recent PMI reports suggest intensifying price pressures. China’s PBoC has likely begun the tightening process. See last week’s post: CHINA’S INFLATION PROBLEM GETTING WORSE. The WSJ has a great interactive chart on global interest rates.
(…) there are reasons to worry that interest rates are too low across much of developing Asia. Unlike in the U.S. and Europe, output gaps, which measure whether economies are growing at full potential, have closed everywhere but in Japan. That indicates pricing pressure is building as demand for goods and services outstrips supply. Also, commodity prices are rising, and massive flows of capital attracted to Asia puts pressure on asset prices, especially housing.
These factors are "cumulatively threatening to degenerate into significantly higher inflation," says Sanjay Mathur, economist for Royal Bank of Scotland in Singapore. He says real interest rates, which take into account the effect of inflation on borrowing costs, are "exceptionally low relative to history." (…)
Complicating interest-rate policy throughout Asia is China’s go-slow currency appreciation. Many of the region’s other economies are dependent on exports for growth and are reluctant to raise interest rates because it will lead to higher currencies and less competitive export industries.(…)
To keep a lid on appreciating currencies, many Asian central banks have aggressively intervened in foreign exchange markets, snapping up dollars and building up massive currency reserves. Twelve of Asia’s largest economies have accumulated $480 billion in reserves so far this year. Almost half of that has occurred outside China.
But all that currency intervention can exacerbate inflation. Keeping currencies cheap makes imports such as oil and other raw materials expensive, contributing to rising domestic prices.
To conduct the intervention, central banks effectively have to print their own money to buy dollars. If they don’t counterbalance the effects of that money printing with a process called "sterilization," in which the banks sop up money by issuing local currency bonds, the money supply can swell. Economists at Standard Chartered figure Indonesia has sterilized about 15% of its interventions this year. Through October, those interventions have increased Indonesia’s reserves by $26 billion.
One country isn’t waiting. Australia, whose growth is closely linked to Asia thanks to its booming mining sector, has raised rates seven times since last year, most recently last Tuesday. Australia has also let its dollar strengthen sharply. That has hurt some of its exporters, but doing so protects the economy from imported inflation.(…)