New U.S. stance won't burn Asia's economies

New U.S. stance won't burn Asia's economies

SINGAPORE (Reuters): The U.S. Federal Reserve's move towards a tightening bias will affect capital flows in and out of Asia, but the region is well insulated against any adverse impact of more restrictive U.S. monetary conditions.

The Fed discarded the neutral policy stance it had held since Nov. 17 last year, although Tuesday's move came as little surprise to financial markets after some worryingly strong inflation data last week.

In the past when currencies were fixed, Asia was more of a slave to changes in U.S. rates because of the need to maintain currency levels.

But at the current stage of Asia's economic cycle, higher U.S. rates do not presage the end to Asia's rate cutting cycle, and in many countries further cuts can be expected.

"Asia should be able to decouple from the U.S. interest rate cycle for two reasons," said Quah Hong Chye, strategist at HypoVereinsbank in Singapore.

"First, Asian currencies, other than the Hong Kong dollar, are no longer pegged to the U.S. dollar. Secondly, credit growth across the region is still very soft... Banks have more deposits than they have people to lend to so rates will come off regardless of Fed moves."

Even in Hong Kong, where the local dollar is still pegged to the greenback, the Hong Kong Monetary Authority's Deputy Chief Executive David Carse was quick to point out that there was still scope for lower prime rates.

"The arithmetic is quite clear. You've got U.S. prime at 7.75 (percent), you've got Hong Kong prime at 8.25. You can see there is a difference there of 50 basis points, which could allow some scope for a small reduction in interest rates," he said.

Even if a change in interest rate differentials does have an impact on the regional currencies the authorities will be relaxed.

They are far more interested in spurring growth in a low inflation environment by cutting interest rates rather than protecting the levels of their currencies.

Countries like South Korea have been actively intervening to push their currency lower for the sake of export competitiveness so a firmer U.S. dollar is not likely to unduly worry central banks.

In the Philippines, phone giant Philippine Long Distance Telephone announced a 55 percent drop in first quarter net income, blaming the stronger peso.

Analysts said the Fed's decision may not have been made just on the back of an apparent upturn in U.S. inflation data. Other factors may well have influenced the committee.

"I think the Fed was looking at the international environment as well as the domestic environment when it decided to adopt a tightening bias," Steve Brice, regional treasury economist at Standard Chartered Singapore, told Reuters Television.

He said better economic data from emerging markets was coloring the Fed's view over the possibility of further global market turbulence, but warned that risks remained in countries like Russia and Indonesia.

Potential economic trouble spots like these were probably staying the Fed's hand on rates for now, he said. The Fed left the key Fed funds target rate unchanged at 4.75 percent.

Analysts said even in Japan, over time, the relationship between dollar/yen and interest rates is actually very weak.

HypoVereinsbank's Quah noted that even when the Fed went on a sequential tightening in 1994, the dollar actually collapsed because the tightening was in response to an overheated economy with a large trade deficit making financial assets unattractive.