Forget the Fed, EM Central Banks Are Already Hiking

Summary

• Hungary and the Czech Republic became the first EU countries to hike rates, with both central banks pushing through policy rate increases earlier this week. They join Brazil, Russia, Turkey and Ukraine with rate hikes elsewhere in EM this year.
• Chile looks set to be the next EM to hike, with the minutes from the June policy meeting showing a rate hike was already discussed. Colombia may also raise rates soon.
• With Brazil and Russia set to hike rates further this year, Asia looks to be the laggard. South Korea will likely be the first in the region, but that remains some way off.

EM rate hikes kicked off in March with three hikes within a week from Brazil, Turkey and Russia. Hungary and the Czech Republic joined them this week, pushing through the first hikes in Europe. Brazil and Russia have continued to raise rates in recent months, and more hikes are ahead. Hungary and Czech Republic have also committed to more. We review which other central banks may join them, and why some may not despite similar inflation dynamics.

CEE Joins the EM Hiking Cycle

Back in March, we wrote about who might hike interest rates next after the initial three central banks. We listed the Czech Republic, the Philippines, South Korea and India. Hungary was not on our list partly because, under Governor Matolcsy, the central bank had been one of the most dovish in EM. But a rapid run-up in inflation above the NBH’s 3% +/-1pp tolerance band ended the era of ultra-loose policy.

At 5.3% (HICP basis), Hungarian inflation is the fastest in the EU. Poland is next at 4.6%. Romania and the Czech Republic are also within the top eight. But on an EM basis, Turkey at 16.6%, Brazil at 8.1%, India at 6.3%, Russia at 6.0% and Mexico at 5.9% are all ahead of CEE. Turkey’s interest rate outlook is highly political given the CBRT governor’s removal following the 200bps hike in March. But the rest of the high-inflation EMs, excluding India, are contenders for rate hikes this year.

But one factor clouding comparisons of EM monetary tightening is QE. Since the pandemic began, an increasing number of EMs turned to QE to loosen monetary conditions. And contrasting AEs, EM central banks did not always wait until the zero lower bound on rates was reached. The RBI is the most recent EM central bank to launch a QE programme, and at a policy rate of 4%, reflecting the need to anchor yields amid rising sovereign financing needs. Expanding EM monetary policy toolkits therefore means sequencing matters for tightening policy. And EMs are taking a different approach here, particularly within CEE.

Hungary said on Tuesday its QE programme would continue despite the rate hike, with the central bank taking a flexible approach to purchases. Last week’s NBH purchases were in line with the recent average at HUF61bn, taking the total to HUF2460bn. Once the stock reaches HUF3000bn, presumably by around end August, another revision will occur (the last revision was in April once the stock hit HUF2000bn). Earlier comments on maintaining a ‘lasting presence in the market’ suggest QE could continue for some time and therefore at the same time as the NBH continues to raise rates.

Poland, which has the lowest ex-post real policy rate in EM and the lowest ex-ante real yields, is still sounding relatively dovish. The NBP has switched to a data-driven approach for policy and dropped its earlier reference to the lack of sufficient zloty depreciation weighing on the recovery, but any discussion over possible rate hikes by some MPC members is quickly countered by the dovish majority. And Governor Glapinski has stated that QE will be phased out before any rate hikes are implemented. Given no discussion over tapering is underway, rate hikes this year seem unlikely. For now, the NBP remain resolute that inflation is driven by supply-side factors and one-offs, with no need to reign in monetary policy accommodation to anchor expectations.

The Czech Republic did not opt for any QE programme during the pandemic, removing any sequencing issues from the switch to policy tightening. The combination of above-target inflation, a strengthening recovery and a traditionally hawkish central bank had meant the CNB were one of the most likely to hike. Contrasting the NBH or NBP, the CNB were also hiking rates through 2017-2019. This week’s rate hike was likely the start of a gradual normalization to get the policy rate back to the pre-pandemic 2%, or broadly a zero real policy rate.

Asia to Lag on Rate Hikes

We no longer include India on our list of EM countries likely to hike. While the worst of the country’s COVID crisis looks over, the delayed recovery and increased pressure on government finances have prompted a very pro-growth stance from the RBI. It launched a QE programme (G-SAP) in April and made several new liquidity facilities available to support the economy’s worst-hit sectors. And while inflation is again above target, this is not too unusual for the RBI given the high food-driven inflation in late 2020.

Consensus forecasts for rate hikes show Asia lagging well behind on expected rate hikes (Table 1). Above-target inflation in South Korea (2.6%) and a strengthening domestic economy have triggered BoK to state that they will not be late in raising rates and that hikes will start ‘at an appropriate time this year’. But with Korea’s recovery lagging those of both China and Taiwan and some COVID-related restrictions staying in place, the prospect for rate hikes remains several months off.

In the Philippines, inflation remains above target at 4.4%, leaving some risk of rate hikes. But this is down from earlier highs and, combined with a slower-than-expected recovery, leaves BSP focus on supporting growth. Recent currency weakness nevertheless will add to inflationary risks.

Talk of cuts in China rates has also receded since the start of the year. This is due partly to the lack of inflationary pressures, with CPI the lowest in EM at 1.3% YoY, and partly to ongoing concerns about the strength of China’s domestic recovery. Policymakers have pointed to stability in monetary policy while simultaneously targeting ongoing vulnerabilities in property markets, commodities and the country’s highly leveraged corporates.

Diverging Performance Across EMFX Partly Explains Different Timings on Rates Normalisation

At the other extreme is Latam. While Brazil is the only country in Latam to have hiked so far, economists expect central banks in Chile and Colombia to follow. It is less clear for the usually dovish Banxico, but even here, some economists expect hikes by year end. This seems surprising given Asia is still expected to be a significant driver of global growth this year, and Latam the laggard, partly on the back of a slow vaccine rollout.

Brazil, alongside Mexico, Turkey, and Russia, saw fairly significant currency weakness last year, adding upward pressure to import prices. This was not so in Asia where, barring modest weakness in India and Indonesia, currencies ended the year stronger. And partly because of this, inflation is higher in Latam and most of EMEA compared with Asia (again ex India).

Overall, in addition to the four central banks now in hiking mode (Brazil, Russia, Hungary and Czech Republic), the next most likely contender to join them now appears to be Chile. A rate hike was already discussed at the June meeting, according to the recent minutes, as inflation is expected to remain above target and the recovery to remain robust. And in Colombia, the recent jump in inflation has some economists also pencilling in rate hikes for July. We see EM hikers as well placed for further FX appreciation.