By Karin Strohecker
LONDON, March 11 (Reuters) – The oil price spike brought on by the war in Iran has, for now, short-circuited a monetary easing push among emerging market central banks from Poland to Turkey as policymakers reckon with a sharp uptick in inflation expectations and rising risk aversion.
Following a raft of shocks – from the COVID pandemic to Russia’s invasion of Ukraine – that roiled markets, hit growth and fuelled inflation, central banks had finally been growing somewhat optimistic again about global economic resilience and receding price pressures.
But the widening conflict in the Middle East triggered by Washington and Israel’s bombing campaign against Iran saw oil prices soar to nearly $120 per barrel on Monday, the dollar gain ground and a rise in U.S. Treasury yields – a proxy for borrowing costs for emerging markets.
Although some of those moves have since been reversed, the outlook for inflation and global economic growth at a time of increasing geopolitical turmoil remains volatile.
Just before the war broke out in late February, 10 out of a sample of 15 major emerging market central banks had been expected to ease policy rates by at least 10 basis points in the six months to follow.
On Tuesday, however, that number had shrunk to just six, and the amount of easing forecast for those still expected to lower rates had also decreased, JPMorgan calculations showed.
“Central banks across emerging markets are likely to increasingly signal a ‘wait and see approach’ pending resolution of Iran conflict-related uncertainty,” said Petar Atanasov, Co-Head of Sovereign Research and Strategy at Gramercy Funds Management.
EMERGING EUROPE SHIFTS FROM EASING TO POSSIBLE TIGHTENING
Emerging markets are not alone. The past week has also seen a sharp scaling back of rate-cut bets for the U.S. Federal Reserve.
But the shift appears most pronounced in emerging Europe, where market pricing for the Czech Republic, Hungary and Poland indicated a swing from easing to potential tightening in the next six months.
Policymakers in Poland conceded that wiggle room for lowering rates had shrunk in recent days, while their peers in Hungary and the Czech Republic have acknowledged the risks and uncertainties reverberating from the Iran conflict.
Reliance on energy imports was an important factor, said Juan Orts, CEEMEA Economist at Societe Generale.
“In (Central and Eastern Europe) for example, the likes of Poland and Hungary are quite sensitive to oil prices,” he said.
A BALANCING ACT BETWEEN INFLATION RISKS AND GROWTH WOES
That uncertain outlook for crude and overall higher energy prices is at the heart of the balancing act facing emerging markets globally, analysts said, as central banks are forced to weigh concerns over rising price pressures against the impact on growth.
“It’s a negative shock for growth,” said James Lord, Global Head of FX and EM Strategy at Morgan Stanley. “It’s a sort of tax on consumption, and it’s potentially something that will cause central banks to have tighter policy than they otherwise might given the inflation risks.”
In Latin America, markets priced less easing for Brazil, though the central bank, which is scheduled to publish its interest rate decision on March 18, is still expected to deliver a rate cut as policymakers face anaemic growth. The central bank paused an aggressive tightening cycle last July and has since kept the benchmark rate at 15%, the highest in nearly two decades.
Another flash point is Turkey – an energy importer highly sensitive to inflation pressures – with the central bank scheduled to publish its rate decision on Thursday.
“We expect the CBRT (central bank) to respond by pausing its rate cutting cycle, awaiting further developments in terms of the likely duration of the conflict and related economic ripple effects,” said Gramercy’s Atanasov.
While the Middle East conflict with all its knock-on effects may prompt central banks to slow rate cuts or pause them in the near term, there is a lot less visibility down the line.
In 2021 and 2022, with economies still emerging from the pandemic and suddenly facing shocks related to the outbreak of the Ukraine war, emerging market central banks were among the first to hike and tackle inflation pressures, while many of their peers in developed economies falsely believed the situation would be transitory.
Once again, much will hinge on central bankers’ judgement on how lasting the energy price rise and subsequent inflationary fallout will be, South African Reserve Bank Governor Lesetja Kganyago told Reuters.
Underestimating its persistence would require a more aggressive – and more costly – stance down the line, while moving early to tackle inflation would allow for smoother policy actions over a period of time, he said.
“That was the lesson of 2021/2022,” Kganyago said. “The central banks that started to act early found that they didn’t have to act aggressively … in one step, which is what ended up happening with the central banks that only reacted in the second half of 2022.”
(Reporting by Karin Strohecker; Additional reporting by Libby George; Editing by Joe Bavier)
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