Synchronized Tightening – On Your Mark!
07 June 2022
Read Time 2 MIN
The ECB’s rate setting meeting will be closely watched after a hawkish surprise in Australia – the National Bank of Poland, however, will have to make its move a day before.
Global Tightening Cycle
The synchronized tightening narrative got an extra boost this morning, following Australia’s surprising 50bps rate hike. The European Central Bank (ECB) meeting on Thursday is the next big milestone - the market is still pretty cautious, seeing no change in June, a modest liftoff (+25bps) in July, and a more sizable hike (+42.5bps) only in September. A more decisive hawkish shift in the ECB can be challanging for central banks in emerging markets (EM) Europe, many of which want to slow down the pace of tightening, arguing that rate hikes can only affect domestic price pressures. Poland’s rate-setting meeting tomorrow will be an important case. The meeting takes place before the ECB – and against the backdrop of fairly “cloudy” guidance by Governor Adam Glapinski. The consensus believes the central bank will stick with +75bps – a smaller 50bps hike (with annual inflation running close to 14%) would be a major negative surprise.
Rate Hikes In LATAM and EM Asia
A smaller rate hike in Chile this afternoon should cause less market commotion – the expected 75bps move would come after the “oversized” 125bps hike in May, with the real policy rate adjusted by expected inflation already well in positive territory (unlike Poland). Chile’s steadfast and transparent monetary policy reaction function is one of the reasons why local bonds outperformed Poland’s so far this year (on multiple time horizons). A slower pace of tightening might no longer be an option in EM Asia, where inflation continues to catch up with EM peers in other regions. Philippine headline inflation accelerated sharply to 5.4% year-on-year in May – another big move after an earlier upside surprise in Thailand. And the incoming governor of the Philippine central bank is not taking any chances, signaling at least two more hikes this summer.
Higher Global Rates and Debt Service Costs
Synchronized tightening and higher global rates create a lot of problems for lower-income EMs, forcing them to spend more resources on debt service (see chart below) instead of development. This is one of the reasons why the IMF now argues that domestic debt “is likely to play a larger role in the resolution of future sovereign debt crises”. One observation (from the chart below) is that interest payments as a percentage of GDP in EM and developed markets (DM) are now expected to converge at a higher level vs. pre-pandemic – with QT and rate hikes erasing DM’s low debt costs advantage in the coming years.
Chart at a Glance: Interest Payments – Convergence
Source: International Monetary Fund, Fiscal Monitor (April 2022)
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