Flash Notes

Taiwan CBC unexpectedly cut its policy interest rate by 12.5bps to 1.75% on Thursday. Bloomberg survey showed that13 out of 24 economists were expecting no change. We have flagged the possibility of a rate cut, noting that the CBChas since 13 August guided the overnight interbank call loan rate lower from 0.37% to 0.32% on 24 September, thelowest since 2011. This coincided with the period of China’s policy rate cuts as well as Taiwan’s own dismal data releases.

    The rate move on Thursday was the first since the last rate hike in July 2011, highlighting concerns following eightmonths of CPI deflation and further declines in the export orders and industrial production in August. Central bankGovernor Perng Fai-nan said that Taiwan’s real interest rates are still relatively high and the CBC is not worried aboutthe funds outflows after the rate cut. He expects 3Q economic growth to moderate further from 0.52% y/y in 2Q. TheDirectorate-General of Budget, Accounting, and Statistics (DGBAS) forecasts GDP growth of 1.01% in 2H15, down fromthe 2.14% in 1H15. This will bring the full-year growth to just 1.56% from 3.8% in 2014 and is markedly lower than thatof potential output.

    Headline CPI has been in deflation for the 8th consecutive month in August while WPI has declined for a year at asharper pace. Core inflation which excludes prices of fruit, vegetables, and energy has averaged 0.82% over the sameperiod. The DGBAS forecasts average deflation of 0.19% for 2015 and expects some rebound to 0.74% in 2016. Overall,this still points to a mild inflation environment in Taiwan.

    In the monetary policy statement, the CBC highlighted uncertainties from China’s economic slowdown, the RMBdepreciation, timing of Fed’s rate normalization and the volatile financial markets. The dovish tone suggests that thereis room for further rate cut and we expect another 12.5 bps cut in 4Q15 quarterly meeting to bring the policy rate to1.625% by year-end.

    USD/TWD ended near-flat at 33.260 on Thursday but one-month USD/TWD non-deliverable forwards rose as much as0.95% to a high of 33.398. The TWD has depreciated by 1.8% since the start of this week. With lower domestic interestrates and expectation of US Fed “liftoff”, we continue to see upside risk in USD/TWD. We expect the pair to trade near33.30 by end-2015 and to 34.10 by mid-2016.