By Natalia Gurushina Chief Economist, Emerging Markets Fixed Income
DM central banks are in a catch up mode, but many EMs are still frontloading hikes, so the policy rate differential between EM and DM is peaking but still substantial.
ECB’s Hawkish Liftoff
The European central bank (ECB) delivered a hawkish surprise this morning, initiating the first liftoff in 11 years with a larger than expected 50bps rate hike, and saying that further policy normalization would be appropriate. There were no dissenters, and it looks like inflation concerns overshadowed downside growth risks for now (including a big decline in consumer confidence). The chart below shows that the aggregate policy rate in developed markets (DM) is finally above the pre-pandemic level, and the differential with emerging markets (EM) should narrow more, once the U.S. Federal Reserve follows up with the expected 75bps rate hike next week.
EM Rate Hike Frontloading
Back in EM, the South African central bank was in a hawkish mode as well, stepping up the pace of tightening to 75bps vs. expected 50bps. Rate hikes of this magnitude are not typical for South Africa, but rising inflation risks forced the central bank to act pre-emptively. The South African rand staged a mini-rally after the announcement – a sigh of relief that the central bank’s credibility was preserved. Elsewhere in EM, we thought there was a good chance that Ukraine’s national bank (NBU) would hike its policy rate this morning, following 25% step-devaluation of the currency in order to reduce pressure on the international reserves. However, the NBU opted to stay on hold at 25%, even though its own forecasts now show inflation topping 30% by the end of this year (=negative real interest rate).
Policy Divergence in EM Asia
Finally, monetary policy divergence in EM Asia became more pronounced today, following Indonesia’s decision to keep its policy rate on hold at 3.5%. The central bank’s reasoning boils down to two main points – (1) core inflation is benign (2.63% year-on-year in June), and (2) the global growth outlook is getting less certain. As regards the latter, the post-maintenance re-activation of the Nord Stream-1 gas pipeline from Russia removed some negative tail risks for Europe, but there are a lot of questions about the pipeline’s capacity going forward – and this means potential downside growth risks. The near-term outlook for two other independent global growth drivers – China and the U.S. – is also getting less optimistic. China’s 2022 forecast was cut to 4% this morning and the U.S. projection might drop below 2% very soon. Indonesia’s central bank is one of the two policy “holdouts” in EM Asia. Thailand is yet to raise its key rate from the pandemic low as well. So, stay tuned!
Chart at a Glance: Policy Rates in EM and DM – Who Is Catching Up Now?
Chart at a Glance: Policy Rates in EM and DM – Who Is Catching Up Now?
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation– Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI– JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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