EM Rate Hikes – Aggressive, But So Is Inflation

By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income Strategy
Van Eck Associates Corporation

EM central banks continue to tighten, addressing new inflation risks. Earlier frontloading allows some to maintain (Peru) or even slow the pace of rate hikes (Brazil). But others (Poland, Uruguay, Sri Lanka) have to move faster. 

EM Rate Hike Frontloading

Poland’s “oversized” rate hike earlier this week was clearly contagiousUruguay followed up with an equally impressive +125bps move (vs. 75bps expected) yesterday, as inflation continued to surprise to the upside. And Sri Lanka nearly doubled its policy rate to 13.5%, as surging inflation (18.7% year-on-year in the capital city of Colombo) and the rapidly depreciating currency (down by 56% vs. U.S. Dollar since early March) led to massive street protests. The rate hike came straight after the parliamentary approval of some fiscal measures, and was followed by an avalanche of headlines about other orthodox policy measures, which suggests that talks with the IMF are moving in the right direction and having an impact on policy-making.

EM Real Policy Rates Policy Cushions

Now, Brazil might be winding down its hiking cycle, but the overall amount of tightening is very much “aggressive”. In particular, Brazil is among very few emerging markets (EM) where the real policy rate – adjusted both by trailing and expected inflation – is now positive. Further, the real policy rate based on expected inflation is above neutral (see chart below), i.e. contractionary. That’s aggressive. And this is the backdrop against which we should look at today’s upside inflation surprise. Yes, it was disappointing (11.3% year-over-year), and the diffusion index is still very high (76%), but policies that should pave the way for disinflation are already in place and will be affecting prices with a lag. In addition, the currency appreciated a lot lately, and this should help to reduce future inflation pressures as well.

Different Pace of Rate Hikes in EM

Elsewhere in EM, Peru maintained the pace of rate hikes (sizable +50bps), and it looks like India is preparing for the liftoff. The central bank raised its inflation forecasts and introduced a higher floor to its interest rate corridor. In LATAM, Chile’s big upside inflation surprise (9.4% year-on-year) signals that it is premature to talk about a slower pace of rate hikes, despite a dovish surprise in March. The central bank’s minutes should be released next week, and it should be an important read. Stay tuned!

Chart at a Glance: Brazil Real Policy Rate No Longer Negative

Chart at a Glance: Brazil Real Policy Rate No Longer Negative

Source: VanEck Research; Bloomberg LP

Originally published by VanEck on April 8, 2022.

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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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