DM central banks still hawkish, but EMs set to lead global rate cutting cycle

DM central banks still hawkish, but EMs set to lead global rate cutting cycle. Photographer: Tatsunori Misawa/Bloomberg News
DM central banks still hawkish, but EMs set to lead global rate cutting cycle. Photographer: Tatsunori Misawa/Bloomberg News

Summary

  • EMs have managed to tame the inflation beast to a considerable extent. However, there are some downside risks which can revive inflationary pressures

The divergence between central banks in emerging markets (EMs) and developed markets (DMs) on the monetary policy front is expected to widen. Some key DM central banks continue to be hawkish. The European Central Bank (ECB) and the Bank of England (BoE) hiked interest rates at their latest meetings even as the US Federal Reserve (US Fed) chose to pause to observe the effects of its previous monetary policy decisions. That said, there is a probability of two more rate hikes by the US Fed in this calendar year.

“The heads of several of the world’s most important central banks agreed at a conference (in Sintra, Portugal) on Wednesday that tighter monetary policy may be needed for longer than previously expected. The agreement among central bankers - including US Fed Chair Jerome Powell and ECB President Christine Lagarde - on the need for higher rates put markets under pressure," Swiss-based research house LGT said in a note on 29 June. Note that a scenario of higher interest rates for longer is certainly a dampener for equity market sentiments.

In contrast, most EM central banks appear to have reached the end of their rate hiking cycles. So, they may well be bracing for interest rate cuts. In fact, according to Nomura, EM central banks would lead the global rate cutting cycle. The fundamental reason for this is that there is emerging evidence that inflation is falling faster in EM than in DM, said the Nomura report. Also, the economic growth momentum in some of the EMs is subdued.

“We believe the stage is being set for EM central banks, including India and Brazil, to lead the global rate cutting cycle in H2 and that this will be the trigger for a market reassessment of risk versus return in EM. Investor discrimination based on economic fundamentals will come back into vogue," said the Nomura report.

As things stand, EMs have managed to tame the inflation beast to a considerable extent. However, there are some downside risks which can revive inflationary pressures thus weighing on EM central banks' decision on interest rate cuts. “A key risk to our outlook of inflation abating faster in EM than DM is a renewed surge in commodity prices, which could be driven by a worsening El Nino event, or an intensification of the Russia-Ukraine war," cautioned the Nomura report.

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