Doves to rule the roost in emerging markets

July 18, 2012

Interest rate meetings are coming up this week in Turkey,  South Africa and Mexico.  Most analysts expect no change to interest rates in any of the three countries.  But chances are, the worsening global growth picture will force policymakers to soften their tone from previous months; indeed forwards markets are actually pricing an 18-20 basis-point interest rate cut in South Africa.

Doves in South Africa will have been encouraged by today’s lower-than-expected inflation print, coming soon after data showing a growth deceleration in the second quarter of the year. Investors have flooded the bond markets, betting on rate cuts in coming months. In Turkey and Mexico, no policy change is priced but a few reckon the former, reliant on a policy of day-to-day tinkering with liquidity, may narrow the interest rate corridor in a nod to slowing growth.

For now, all three banks could be constrained from cutting rates by fear of currency volatility and the potential knock-on effect on inflation. Of South Africa, analysts at TD Securities write:

In this environment, the odds of a rate cut to 5 percent in the near term are not negligible but… easing rates at this point would increase the risk of inflationary pressures intensifying via the exchange rate channel.

But the feeling overall is that if central banks don’t cut rates this month they will do so soon. In fact, policymakers are already behind the curve with monetary easing, says Benoit Anne, head of emerging markets strategy at Societe Generale.  He reckons that with the U.S. Fed dragging its feel on QE3, worsening growth will soon overshadow any concerns for the currencies and inflation. (South Korea stunned investors last week with its first rate cut in three years). Anne says:

We won’t get QE3 soon and a number of central banks in Asia have started shifting policy towards easing. To me that suggests we don’t need the green light from the Fed any more, there is enough justification at this point for emerging central banks to go ahead without the Fed. In some places like Mexico the economy has been resilient and the case for rate cuts is not well established. But they need to project a few months ahead as the slowdown could be considerable.

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