Fed cut sets stage for Asia’s next easing wave amid trade strains

Asian central banks may find more room to ease policy after the Federal Reserve cut interest rates by a quarter percentage point Wednesday and signaled more reductions ahead, as the region contends with trade headwinds and currency pressures.

The cut brought the Fed’s benchmark overnight lending rate to 4%-4.25%. Fed Chair Jerome Powell framed the decision as a “risk management cut,” rather than something more directed at shoring up a weak economy, and indicated two more cuts are likely this year.

The Fed’s move may have also narrowed the gap between U.S. and Asian bond yields, easing currency concerns and giving some Asian economies — particularly those facing greater domestic headwinds — more room to lower rates, said Peiqian Liu, Asia economist at Fidelity International.

“The overall policy stance across the region will likely become more accommodative,” Liu said.

Some Asian banks have already begun to run ahead of the Fed to blunt the impact of the Trump administration’s tariffs.

These include the Bank of Korea, which cut its policy rate to an almost three-year low in May, while the Reserve Bank of Australia slashed rates to a two-year low in August. India’s central bank delivered an outsized cut of 50 basis points in June.

Still, differences will persist due to varying economic conditions in these countries, Liu said, pointing to domestic inflation and the lingering effects of exports being rushed out before the U.S. tariffs took effect. 

Export-dependent economies like Japan, South Korea and Singapore all posted better-than-expected economic growth in the second quarter of the year, with Seoul and Singapore narrowly avoiding a technical recession.

Several Asian central banks, including the Bank of Korea and the Reserve Bank of India, are likely to continue to cut rates in the fourth quarter, said Betty Wang, lead economist at Oxford Economics.

“Earlier concerns about rapid currency depreciation have proven overstated, and a weaker dollar has instead created additional room for Asian central banks to ease further towards the end of this year in a response to rising growth concerns,” Wang said.

Chi Lo, senior market strategist Asia Pacific at BNP Paribas Asset Management, echoed that view, noting that real interest rates across much of Asia remain above historic averages, giving central banks room for further rate cuts.

A notable exception has been India, which posted strong economic growth over the last two quarters, driven by domestic demand rather than exports.

India will likely prioritize domestic growth due to the weaker external demand and higher U.S. tariffs, with further policy easing, Fidelity’s Liu said.

India’s inflation rose in August for the first time in 10 months to 2.07%, just above the lower bound of the RBI’s 2%–6% target range. There is “ample room” for further policy easing to cushion growth headwinds if needed,” Liu said.

BNP Paribas’ Lo noted the Fed is still caught between slower growth and fears about higher inflation in the U.S., which constrains it to a “short rate cut cycle.”

Economic fundamentals in Asia, including resilient growth figures and low inflation, suggest that the region could see a longer rate cut cycle, especially with the U.S. dollar on a weak trend, Lo added.

However, two major Asian economies have defied the rate-cutting trend: China and Japan.

For Japan, its central bank is not only holding rates, but is aiming to raise them as it strives to normalize its monetary policy.

Economists expect the Bank of Japan to keep policy steady at its meeting Friday, with further hikes later this year as inflation has stayed above the BOJ’s 2% target for over three years.

China’s central bank also left its short-term rate unchanged Thursday at 1.4% in the wake of the Fed’s rate cut, balancing the need for stimulus with concerns of fueling a stock market bubble that could repeat the crash of 2015.

China’s economy has shown signs of fatigue in August, with export growth slowing more than expected and key economic indicators like retail sales and industrial output coming in lower than economists’ estimates. 

The Chinese yuan will likely retain its strength amid a dollar downcycle as “the current consideration for China is probably not to let the renminbi appreciate too much, rather than defending it from depreciation,” said Tianchen Xu, senior economist at Economist Intelligence Unit.

The offshore yuan has gained about 3% against the dollar this year and last traded at 7.1083 on Thursday.

Economists largely expect the yuan to strengthen to 7 against the greenback by the end of this year as Beijing focuses on countering deflation and bolstering growth. 

Nonetheless, the Fed’s cut opens up options for the People’s Bank of China, Xu said, expecting China to press ahead with monetary easing in the medium term, given its domestic economic challenges.