Monetary policy to tighten gradually in the region, impact on growth to remain subdued

No more easy money

After the GFC and prior to 2017, Asia-Pacific economic growth has remained remarkably high, as the region performed much better than the world average. Yet, the expansion was pretty unbalanced with: (i) rapid growth in credit; (ii) deflationary pressures in the context of overcapacities accumulation; and (iii) unsynchronized demand drivers (exports down, domestic demand up).

Since 2017, though, things have changed somewhat. Output expansion has remained strong (+5.0%), but is now associated with manufacturing reflation. Excess capacities are diminishing, and demand growth shows some synchronization as both exports and domestic sales expand at a steady pace. More importantly, this year’s capex cycle looks more promising on the back of higher risk appetite and positive corporates sentiment.

Against this background, central banks’ priorities are shifting toward a tightening bias. We expect all central banks to tighten their monetary policy gradually over our forecast horizon (2018-19).

Five reasons back our forecasts: First, inflation is set to pick up speed. Second, economic conditions― namely, growth outlook and unemployment rates―are better oriented, which gives some comfort to central banks in raising their key rates. Three, downward pressures on the currency are expected to increase with tightening monetary policy in the US, China and Japan. Four, asset prices have increased at a rapid pace in markets such as mainland China, Hong Kong, Australia and New Zealand, which creates financial stability risks. Fifth, strong growth in credit must be tamed to improve growth sustainability.

Overall, the slow pace of tightening would allow Asia pacific economic growth to remain in a solid range of +4.8% in 2018.

China: Taming financial risk

Disinflationary pressures have reduced on the back of rising producer prices, and we expect inflation to pick up speed to +2.5% in 2018 (from +1.6% in 2017).

Economic conditions have improved with both exports and domestic demand continuing to grow in sync, and a strong labor market (unemployment rate at 3.9%). Against this background, the authorities are set to focus on reducing financial risks―namely, high debt (non-financial corporate debt at 163% GDP), high real estate prices, and high risky lending activity (“shadow banking”).

As such, we expect a continued tightening of regulations.

The government has already (i) enacted property-related measures such as purchase restrictions, higher down payment requirements and mortgage rates, and (ii) improved the regulatory framework to reduce risky lending practices (shadow banking activities, e.g.) through tighter supervision.

The PBoC is set to raise its benchmark lending rate, but at a slow pace (from 4.35% to +4.60% by end-2018) in order to keep growth rates in a manageable range.

Japan: A two-phase tightening

On the monetary policy front, the BoJ is set to stick to its target for the 10-year JGB yield (“around zero percent”) for the time being.

Yet, with a tightened labor market (unemployment rate at 2.7% currently) and a gradual rise in inflation, the central bank could start to signal a more flexible approach to the +2% price stability target later this year. In the absence of external shocks and assuming that wages start to pick up speed after spring negotiations, we could see further inflationary pressures. We expect the 10-year JGB yield target to be raised to 0.1-0.3% (from around 0% now). The short-term policy rate will be kept at -0.1% in 2018 before an increase to 0.1% in 2019 as growth momentum consolidates.

Emerging ASEAN and India: Each country has its own pace

We see two groups of markets in the region. In Malaysia and the Philippines, central banks are expected to tighten their policy this year, as: (i) inflation moves steadily within their target ranges (2-3% and 2-4%, respectively); and (ii) growth strengthens.

Both markets are set to record a firm growth in 2018 (+5.0% in Malaysia; +6.8% in the Philippines) and the labor market is tightening.

Apart from reigning in inflation, gradual hikes will help avert financial stability risk factors stemming from high household debt ( Malaysia) and downward pressure on the currency in the context of Fed and PBoC hikes.

In India, Thailand and Indonesia, we expect the first policy rate hikes to happen in 2019.

Economic growth is picking up but is fragile, underpinned by robust trade growth and a rise in public infrastructure spending ( Thailand and Indonesia) and a rise in foreign direct investment (India and Indonesia).

As inflation is still under control, we expect central banks to adopt a wait-and-see approach until economic growth consolidates above +3% in Thailand, 5% in Indonesia and +6.5% in India.

High-income markets: Moving policy rates up

All high-income markets ( Hong Kong, Singapore, Australia, New Zealand and South Korea) in the region have tightened their regulatory framework (constraints on housing purchases, tighter lending rules) in order to reduce housing risks and high household debt. We expect the next moves to be broader, as growth has consolidated and inflationary pressures are dissipating.

Monetary policy rates (end year)