Taiwan's central bank cut policy rate for the first time in six years

Taiwan's central bank cut rates by 12.5bps yesterday, taking the benchmark discount rate to 1.75% from 1.875%. The widening of a negative output gap, easing of inflation expectations and relatively high real interest rates were cited as the main reasons behind the rate move, according to the policy statement. 

A 12.5bps cut in the discount rate is normally translated into a 6-7bps decline in the 3-month central bank bills rate and interbank rate. In fact, the short-term money market rates have already fallen slightly over the past one month thanks to the policy fine-tuning by the central bank. The LTV rules imposed on housing mortgage loans have also been relaxed. This series of easing measures should help to push down banks' lending rates, revive credit growth and provide some support to domestic demand. 

Admittedly, interest rates were low to begin with. The positive effects of a 12.5bps rate cut won't be large. Liquidity conditions have been persistently abundant in the financial system, thanks to excessive savings and insufficient investment opportunities in the domestic market. To effectively boost growth, the loosening of monetary policy should be complemented with an expansionary fiscal policy (to directly create investment demand) and structural reforms (to tackle the supply-side investment bottlenecks). In this regard, any progress will only be made after the January 2016 elections. 

"On the forecast front, we expect the benchmark rate to remain at 1.75% in the rest of this year and in the most of 2016", says DBS Group Research.

The core assumption here is that the short-term growth cycle will bottom out in 4Q15. The performance of trade and manufacturing is expected to improve in 4Q15, thanks to a seasonal upturn in the electronics sector driven by demand from the US. Still, we can't rule out the possibility of one more 12.5bps rate cut at December's meeting. The 3Q15 GDP (due Oct) will likely continue to undershoot expectations, with the risk of turning negative on the YoY basis. 

A rate hike by the US Fed, which is widely expected to take place in 4Q15, shouldn't pose a big constraint on Taiwan's monetary policy. Given Taiwan's strong current account and low exposure to external debt, the pressure of capital outflows and currency weakness triggered by rising US rates should be tolerable and manageable. 

"For now, we reckon that the probability of a December rate cut is about 30-40%", added DBS Group Research.