EM Policy Options - To the Drawing Board

Summary

Recent changes in inflation and growth surprises are making emerging markets to re-evaluate their policy options.

EM Inflation, Growth Surprises

The inflation surprise index for emerging markets (EM) has been going down since May. The growth surprise index appears to be flat lining. It is therefore not surprising that an increasing number of EMs are going back to the drawing board to evaluate their policy options. In China, the central bank’s Q2 monetary policy report signaled that “a wall of liquidity” will not be coming back any time soon, despite benign inflation and multiple near-term growth headwinds (the 2022 consensus GDP growth has been cut to 3.9%). The chart below - with interbank rates well below their benchmark - shows why additional rate cuts might not be a policy option of choice either (there is no point), and why authorities are likely to focus on regulatory changes and fiscal channels.

Growth and Pace of EM Rate Hikes

Near-term growth headwinds might be even stronger in Central Europe, which is exposed to higher energy prices and negative spillovers from its main trading partner, the Eurozone. The Czech National Bank kept the policy rate on hold, opting for FX interventions (about 15% of the international reserves since mid-May, according to some sell-side estimates) to cap inflation pressures. Hungary is actively employing fiscal tightening (a surprising surplus in July) in addition to more aggressive benchmark frontloading. So, today’s decision to keep the 1-week deposit rate unchanged looks perfectly logical in all respects. Finally, today’s minuscule downside surprise in Romanian inflation can give the central bank an excuse to tighten at a slower pace going forward.

LATAM Policy Divergence

The inflation and growth landscapes in LATAM look quite diverse. Brazil is exiting its tightening cycle - and rightly so. But other countries/central banks might need to work harder (=hike more) to leave the inflation peak behind. Mexico’s rate-setting meeting will be closely watched this afternoon. The consensus expects another sizable hike of 75bps, following an upside inflation surprise in July. But the statement will be equally important as regards the balance of risks and especially the central bank’s view on growth risks, because Mexico’s manufacturing survey (Purchasing Managers Index) unexpectedly moved into contraction zone in July (48.5). Stay tuned!

Chart at a Glance: China Interest Rates - Lower Without Policy Rate Cuts

Source: Bloomberg LP