Inflation and Fed shift puts EM central banks under pressure to hike
Interest rate hikes by Hungary and Czechia have set the tone for CEE central banks’ attitudes towards rising inflation amid signs that the US Federal Reserve is moving to tighten monetary policy
Policymakers in emerging markets are hiking interest rates faster than analysts had expected as they look to counter concerns about rising inflation and adapt to the US Federal Reserve’s gradual shift towards normalising monetary policy. Hungary and Czech Republic last week became the first EU countries to increase interest rates since the coronavirus pandemic began, with Hungary raising its base rate from 0.6% to 0.9% and the Czech National Bank’s board voting for a 25bp hike in a bid to curb inflation.
The moves came as other major emerging nations including Poland, Russia and Turkey are seeing both headline and core inflation above their target ranges, while the likes of Russia and Brazil have carried out major hikes. “EM rate hikes have started a lot faster than expected,” said Edward Glossop, EM economist at Aberdeen Standard Investments in London. “At the start of the year most analysts were not expecting significant interest rate increases, but there has been a broad-based shift in expectations in almost every EM country.”
The eyes of EM investors are firmly on the Fed as it offers clues as to when it will begin to tighten monetary policy, and Treasury yields have widened sharply since the beginning of the year as the recovery in developed economies exceeded expectations. Standard & Poor’s admitted this week that it had been expecting some increase in headline inflation in emerging EMEA by late in the first quarter due to the disinflationary conditions at the start of the coronavirus pandemic last year.
However, inflation in several countries “accelerated faster than we anticipated, and price pressures appear broad-based”, said the rating agency in its third quarter economic outlook.
BEHIND THE CURVE
While Hungary and Czechia are making hawkish moves, some investors are concerned that the rest of the region has not fallen suit. “We are underweight across the region because we think inflation will become a bigger issue,” said Edwin Gutierrez, head of sovereign EM debt at Aberdeen Standard Investments. “It is not facing a crisis, but we think monetary policy is behind the curve.” Higher rates have so far proven to be a strong defence for EM currencies. Both the Russian rouble and the Brazilian real have outperformed EM currencies after the respective central banks caught the eye for their hawkish stance.
The Bank of Russia has raised its key rate three times already this year — a total of 125bp to 5.5% — and has signalled further increases, while Brazil’s monetary authority has delivered three consecutive hikes of 75bp. “Whereas Brazil and Russia are hiking to re-establish their credibility with markets, much of Eastern Europe arguably has more of a macroeconomic foundation to raise rates,” Glossop said.
“There, recoveries are stronger, labour markets were tighter before Covid, and they have had large income support programmes that prevented a dramatic hit to labour markets. This means there are reasons to believe there are underlying price pressures in CEE.” Yet as multilaterals such as the IMF warn of the dangers of a divergent recovery from Covid-19, with most emerging economies having taken a bigger hit from the pandemic than developed markets, some are concerned that the hiking cycle will drag on growth.
S&P said that the uneven global recovery brings “important challenges” for emerging economies. The firm said that, though this was not its base case, earlier than expected hikes by the Fed risked capital outflows from EM, leading to currency depreciation and financial volatility at a time when domestic inflation pressures are significant.