Yield curves likely to steepen

A slowdown in Asian economic growth would normally flatten bond yield curves but a combination of inflation fears and US rate cuts means a steepening is in store for most markets in the region.

Analysts expect yield curves in Indonesia, the Philippines, Hong Kong, Singapore and especially Thailand to steepen most as commodity-fuelled inflation props up long-term yields and further easing by the US Federal Reserve depresses short-term returns.

But analysts say the steepening, which makes longer-term borrowing more expensive, should not hurt government fin-ances significantly and is unlikely to trigger a sell-off by foreign investors, who are now significant players in many Asian markets.

A decade of solid econ-omic performance has reduced budget deficits in the region, and therefore the need for governments to borrow heavily, while foreign investors are more likely to ignore inflationary threats as long as Asian currencies stay firm.

"If the US is on an extended slump, rates will have to be cut domestically to buffer the slowdown," said Vishnu Varathan, an economist at Forecast Pte in Singapore, adding that costly oil and commodities would then cause yield curves to steepen as inflation pushed higher.

Wall Street traders polled by Reuters unanimously expected the Federal Reserve to cut rates again in March, even after a cumulative 125-basis-point cut to three per cent in January.

Analysts expect that move to be reflected in monetary policy in Asia, especially in Hong Kong, where policy is closely linked to that in the US because of a currency peg.

The aggressive rate cuts by the United States will at the very least stay the hand of those Asian central banks that were until recently looking to raise rates to tackle inflation.

"Right now many central banks in Asia who were hawkish appear to have shifted to a more balanced view, and recent comments indicate some flexibility in bias," said Ashish Agrawal, a rates strategist at Merrill Lynch, citing the examples of China, India, Malaysia and South Korea.

Malaysia's central bank held interest rates steady last week, despite underlining inflation as a risk for the economy. South Korea has said that stabilising consumer price growth is its "top policy goal" but the authorities in Asia's fourth-largest economy, which depends heavily on US demand, are also under pressure to ease rates to support growth.

Inflation pressures

Similarly, India's central bank has warned of "upside pressures on inflation" but it held interest rates steady at a policy meeting last week.

Interest rates in India are 4.25 percentage points higher than in the United States, the widest gap in three years, and the Reserve Bank of India is worried that yield-seeking flows will push up the rupee and hurt exporters.

China, which has been raising interest rates and tightening in other ways to prevent its economy from overheating, is now thought by some econ-omists to be looking at loosening policy after the US rate cuts.

The general steepening in yield curves across the region is unlikely to have a major negative impact on government finances or result in a rush from the markets by foreign investors.