SINGAPORE/WASHINGTON The Federal Reserve's return to higher interest rates could lend a hand to beleaguered counterparts in Japan and Europe and signal the end of a long cycle of monetary stimulus across Asia, as central banks from Beijing to Ankara to London reacted on Thursday to the U.S. policy change.
The Fed's widely anticipated and modest rate hike on Wednesday was only its third since the global financial crisis. But it came earlier than investors had expected only weeks ago and it sets the stage for roughly two more hikes this year as the U.S. economy strengthens.
China, the world's second-largest economy, responded Thursday by raising its key policy rates to head off a weakening of its currency. That same reason prompted central banks in Saudi Arabia, the United Arab Emirates, Kuwait and Bahrain to tighten policies within 90 minutes of the Fed's announcement.
Among major economies, the Bank of Japan and the European Central Bank remain locked in an aggressive battle against low inflation and growth. And while the pair are nowhere near raising rates or tapering stimulative bond buying - as Governor Haruhiko Kuroda made clear when the BOJ held policy steady on Thursday - the pair has recently begun sounding more optimistic that their time will soon come.
The dollar shot up by about 25 percent in 2014 and 2015 as the U.S. central bank prepared to raise rates from near zero, and it has stayed elevated even while the Fed got off to a slow and halting start to tightening.
While a stronger dollar cuts costs for exporters in Japan and Europe, boosting such economies, it prompts a flight of capital from fragile emerging economies that still need monetary accommodation.
"At the very least, the Fed's desire to step up the pace of policy normalisation has changed the conversation at many central banks globally," said Sean Callow, an economist with Westpac in Sydney. Further monetary easing among Asian emerging economies, he said, "is now largely seen as only if needed to 'break the glass', not a plausible baseline."
For the BOJ and ECB, however, "the Fed raising rates gives more leeway ... to do the same without it adversely impacting their currency," said Shehriyar Antia, former senior analyst at the New York Fed and founder of Macro Insight Group in New York.
In a surprise, the Bank of England said one of its policymakers voted this week to raise borrowing costs and some others felt it would not take much for them to follow suit, signalling growing pressure to tighten even while rates were kept low at 0.25 percent.
The Fed's shadow was also present in Turkey, where a policy rate was tightened on Thursday, and in Finland, where the central bank forecast the Nordic euro zone economy was picking up pace following a decade-long stagnation. [nL5N1GT177]
ECB President Mario Draghi, who signalled last week less urgency for more stimulus, would welcome U.S. rate hikes that depress the euro. The central bank is paving the way to a gradual phasing out of accommodation and resisting isolated calls from some members calling for more radical action.
Deutsche Bank economists wrote in a note that the ECB "is slowly shifting toward a less dovish stance, with an announcement of a tapering of (asset purchases) towards zero likely by year end."
THE CURRENCY CHALLENGE
The Fed's new policy path is a sea change for global markets used to a decade of easy money. And while emerging markets are showing some signs of strength, with a recovery in commodity prices and growth in exports, they are struggling to fire up domestic demand.
But their freedom to fit domestic rates to local demand conditions is constrained by the need to keep hold of the foreign capital that flooded in seeking higher yields when developed world rates were at rock bottom. And they also need to prevent their currencies from tumbling against a rallying dollar .DXY.
"Even if domestic conditions warrant a cut, fears about exacerbating financial market volatility will keep central banks cautious," said Tim Condon, ING's chief Asia economist. "It definitely complicates life for those central banks that either needed to or wanted to cut rates."
Bank Indonesia, which had cut rates several times last year to boost economic growth, said on Thursday it was closely monitoring U.S. policy tightening and its effect on the dollar, and that it would keep policy steady for now.
Emerging markets had something of a dress rehearsal for this in 2013 when then Chairman Ben Bernanke hinted that Fed bond-buying would soon slow, comments that triggered a "taper tantrum" of volatility and prompted policymakers in India, Indonesia and elsewhere to defend their currencies with higher rates.
South Korea's central bank may no longer be able to ease further, even as it wants to avoid unsettling a highly indebted housing sector. Its policy rates are now barely above that of the Fed and if that yield premium narrows too much, a huge amount of foreign money in its bond market could flee.
The Fed's hike was not the only piece of news that could encourage the world's central banks to a firmer stance.
Elections in the Netherlands, where the anti-EU party of Geert Wilders won fewer seats than expected, came as a relief to markets, though next month's presidential election in France is still hanging over the continent, with the far-right Front National candidate Marine Le Pen showing strongly.
Nodding to this risk over the border, the Swiss National Bank kept its ultra-loose policy in place. Its negative rate policy, in place since 2015, is aimed at curbing demand for the currency in a period of destabilising elections across Europe that could boost anti-establishment parties.
Norway's central bank also kept its key rate unchanged and maintained an easing bias as inflation pressures there remain subdued.
(Rreporting by Vidya Ranganathan; Editing by Will Waterman and Chizu Nomiyama)