Asia rates have room to rise beyond inflation peak

Singapore (Reuters): Asia’s emerging market central banks will need to keep ratcheting up interest rates well after inflation peaks to prevent higher prices from seeping into corners of the economy where they are much harder to dislodge.

Two months after global oil prices began to subside from a spike fed by Middle East unrest, the worst appears to be over for China, Indonesia, and a handful of other Asian economies that struggled to contain inflation this year. But it may be only a short-lived reprieve.

Home-grown inflationary pressures are building, stemming from tight labor markets, rising property values and growing domestic demand, meaning rate rises may continue at least through 2012.

China is the country to watch. Not only is it the biggest player on the block, but it has become a role model for some other policymakers in the region and a bellwether for investor sentiment on Asian emerging markets. “We do expect inflation to roll over in the coming months,” Frederic Neumann, co-head of Asian economics research at HSBC, said in a telephone interview from Hong Kong. “But make no mistake, there is underlying inflation that will not disappear in China.” Neumann thinks last week’s interest rate hike from the People’s Bank of China (PBOC) will be the last of the year but far from the final move of the tightening cycle. A slim majority of economists polled by Reuters on Thursday predicted otherwise, calling for one more one-quarter percentage point increase in bank lending rates by year end.

Benchmark interest rates across Asia remain well below levels that prevailed before the financial crisis exploded in 2008, which argues strongly for more tightening. In India, South Korea and Malaysia, for example, interest rates are running below annual inflation.

Neumann and others worry that easing price pressures may lull policymakers into a false sense of security. Indeed, Malaysia’s central bank held rates steady last week, defying expectations for a rise. That is one reason why economists are looking for evidence of inflation lurking beneath the surface. Similar to the way U.S. economists strip out food and energy prices to focus on “core” inflation, Asia economists are differentiating between cost pressures emanating from globally tradedcommodities and those tied to domestic factors.