By Vidya Ranganathan
SINGAPORE, Dec 17 (Reuters) - The Fed's new policy of flooding U.S. markets with cash may play well into the hands of Asian policy makers if it weakens the dollar, allowing them to cut rates faster and shift focus to limiting currency gains.
Asian central banks will continue easing monetary conditions to soften the impact of a deepening global recession, analysts said, and the Federal Reserve's pushing rates to zero will definitely hasten that process.
But in a region whose lifeline is exports, a more critical concern will be the weakness in the U.S. dollar that the Fed policy engenders, and the impact of a possible recovery of its currencies on exporters' bottom lines.
It means central banks that have hitherto sold dollars to defend their weak currencies would now be trying to keep them from strengthening too much, thereby buying dollars and pumping in local currency funds that their markets badly need.
"We could see central banks coming back into the market and buying dollars because, given the growth and inflation outlook in the region, the last thing the policy makers want is a stronger currency," said Peter Redward, head of Asian research at Barclays Capital.
"Central banks will buy the dollars and leave a lot of the money unsterilised to try and reliquify local money markets."
The Fed took its target overnight policy rate to a record low zero to 0.25 percent on Tuesday and promised to buy more debt and expand its balance-sheet, using tools which are considered forms of quantitative easing, to prop up an economy mired in recession.
The dollar extended a two-week downtrend, hitting 2-½ month lows against the euro
The dollar's retreat has provided some reprieve for currencies such as the rupiah and Korean won which hit their lowest levels in a decade at the height of the credit crisis in October and November this year.
RECIPE FOR DISASTER
Yet, that dollar weakness is far from welcome in a region where exports can account for as much as 200 percent of economic output, and at a time when domestic demand is slowing and main markets in Japan, Europe and United States are in recession.
"What's most important now as far as regional markets are concerned is that they limit the appreciation bias against the dollar," said Dwyfor Evans, a strategist at State Street.
"If you are in a scenario where the rest of the world is slowing down, and your currencies are beginning to appreciate as well against the one of your major export market, that's a bit of a recipe for disaster.
"Not only are you putting your corporates at relative disadvantage, but the end user export markets just aren't there."
PREFERRED INTERVENTION
If Asian policy makers manage to keep their currencies from strengthening so far as to hurt export pricing, the region's new monetary policy mix, owing to the turnaround in currencies, could actually prove to be easier to manage.
So far, central banks had been cutting rates, some such as China and India more aggressively than the likes of Malaysia and the Philippines.
Weakening currencies against a backdrop of falling inflation also played into that policy easing bias, until that point when some tumbling currencies threatened to plunge economies into crisis and required central banks to sell dollars.
Governments in South Korea, India and elsewhere in Asia were both selling dollars to support their currencies and injecting huge amounts of funds in money market operations to replenish the local cash that was being sucked out by the intervention.
Redward sees that trend changing, with some signs already evident in markets such as Hong Kong where the central bank's efforts to stop the currency from rising have generated huge cash surpluses in local markets and propped up the stock market.
"In Asia, we expect rate cuts to be front-loaded as they have been in the last few months," he said, adding that would keep bond yield curves flat and bond prices rising.
The wildcard in this scenario is the dollar. No one is quite sure if it will keep weakening, particularly as the Fed's move forces the hand of central banks in Europe and Japan to adopt similar drastic monetary easing.
Besides, if zero interest rates in the United States force governments to move out of safe-haven Treasuries or investors to seek yield in emerging markets, Asian policy makers could have an additional problem of capital inflows to deal with. (Reporting by Vidya Ranganathan; Editing by Tomasz Janowski)