EM Rate Hikes – Aggressive, But So Is Inflation

April 21, 2022 GeneAka Investment Comments Off

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 contagious. Uruguay 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!