10 May 2022
VanEck Blogs | Emerging Markets Debt Daily
Inflation “Bombs” Keep Dropping

Major upside inflation surprises in EMEA signal that it is premature to talk about ending the tightening cycles. China made an adjustment to improve the monetary policy transmission mechanism.

Inflation Persistence in EM

We are on a research trip in Central Europe this week, and our second day began with a bang – we’ve got major inflation shockers in Hungary (9.5% year-on-year) and the Czech Republic (14.2% year-on-year). The main question is whether central banks in the region are misreading the situation and getting stuck in outdated policy regimes. After all, Brazil felt compelled to raise its policy rate from 2% to 12.75% as annual headline inflation was climbing to circa 12% (this is what the consensus expects for April). At the same time, the Czech National Bank (which is considered the most credible in EMEA) is still below 6% with inflation heading for the high teens – and there is talk about potentially ending the tightening cycle below 7% if the new Governor (to be announced tomorrow) has a dovish policy bias.

EM Matching Fed Rate Hikes

An additional consideration here is that inflation pressures in parts of emerging markets (EM) are still rising, but U.S. inflation might have peaked – we will find out tomorrow if that is indeed the case. If this thesis is confirmed, some EM central banks will have to keep on hiking – in a sense “matching” the U.S. Federal Reserve’s hikes – even though EM inflation is driven, to an extent, by exogenous factors. The problem, however, is that global supply shocks are feeding into core inflation – and we learned during our EMEA discussions this week that this passthrough might be higher and takes less time than in “normal” pre-COVID years. So, the current tightening cycle will have to be extended – and even a whiff of dovishness will be treated by the market as a policy mistake.

China Monetary Policy Transmission Mechanism

Given the overarching importance of global supply chain issues, we continue to keep a close eye on the situation in China. The latest headlines mention tight mobility restrictions – so how do the central bank’s latest policy moves stack up against it? It is encouraging that modified rules for banks’ deposit rates should make it easier to “translate” policy rate cuts into lower deposit and lending rates (=better transmission mechanism). At the same time, the room is relatively small (sell-side estimates suggest up to 50bps) and might be exhausted fairly soon. Still, the expected decision regarding the medium-term lending facility rate now looks a bit more relevant for the real economy. Stay tuned!

Chart at a Glance: LATAM-ization of EMEA Inflation

Chart at a Glance: LATAM-ization of EMEA Inflation

Source: Bloomberg LP

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Natalia
Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income