Emerging market central banks playing catch-up

Developed central banks in the past week have been falling over themselves to loosen monetary policy and secure the proper functioning of financial and credit markets.

The Fed, RBNZ, Bank of Canada, Bank of England and Norges Bank have delivered inter-meeting policy rate cuts of between 50bp and 100bp and our measure of the developed central bank policy rate has been cut 74bp so far in March, the largest monthly cut since December 2008. It is now in negative territory (-0.05%) for the first time in at least 15 years.

This has raised concerns that developed central banks are close to running out of ammunition, at least in terms of policy rate cuts, which have arguably weighed on global equities and contributed to the outperformance of the Dollar, Euro, Swiss Franc and Yen.

In contrast, major Emerging Market (EM) central banks have, with the exception of Bank of Korea and Banco Central de Chile, kept their policy rates unchanged in the past fortnight. This is broadly in line with our view that “the overall pace and magnitude of [central bank] policy rate cuts in Non-Japan Asia will be modest.”

The EM central bank policy rate – a GDP-weighted average of policy rates in 20 major EM economies – was admittedly cut a sizeable 74bp between mid-2019 and end-January 2020 but has been cut only 4bp so far in March, albeit to a new multi-decade low of about 4.3%.

We think EM central banks are concerned that further rates cuts could exacerbate capital outflows and put further downward pressure on their currencies and upward pressure on already high and/or rising headline CPI-inflation.

As a simple rule of thumb we think EM central banks with a high real policy rate and stable/appreciating currencies are more likely to cut their policy rates in coming weeks (see Figure 7). On this basis central banks in India, the Philippines and Taiwan seemingly have room to cut rates.

We also think that the South African Reserve Bank will cut rates at its policy meeting on 19^th March, as long as the Rand remains broadly stable as it has been in the past week.

Developed central banks aggressively loosened monetary policy with more likely to come

Developed central banks in the past week have been falling over themselves to loosen monetary policy and secure the proper functioning of financial and credit markets.

• The Federal Reserve announced a resumption of its purchases of Treasuries and asset-backed securities to the tune of $700bn;

• The European Central Bank – which left its policy rates unchanged at its meeting last Thursday – announced an increase in its asset purchases by €120bn for the rest of the year;

• The Reserve Bank of New Zealand (RBNZ) said on 16^th March said that a “Large Scale Asset Purchase programme of New Zealand government bonds would be preferable” to further rate cuts;

• Reserve Bank of Australia Governor Philip Lowe said on 16^th March that the RBA “stands ready to purchase Australian government bonds in the secondary market” and would announce further measures to support the Australian economy on 19^th March

The Federal Reserve, RBNZ, Bank of Canada, Bank of England and Norges Bank in the past week have also delivered inter-meeting policy rate cuts of respectively 100bp, 75bp, 50bp and 50p and 50bp. Our measure of the developed central bank policy rate – a GDP-weighted average of nominal policy rates in major developed economies and economic blocks – has been cut 74bp so far in March, the largest monthly cut since December 2008 (-78bp) – see Figure 1. Moreover, we expect central banks in Australia and Canada in the near term to further cut their policy rates, currently at 0.50% and 0.75% respectively.

As a result the developed central bank policy rate is now in negative territory (-0.05%) for the first time in at least 15 years, according to our estimates (see Figure 2). The previous low was 0.1% in November 2016. This has raised concerns that developed central banks have or are close to running out of ammunition, at least in terms of policy rate cuts – concerns which have arguably weighed on global equities in the past week and contributed to the sustained outperformance of the US Dollar, Euro and more traditional safe-havens, namely the Swiss Franc and Japanese Yen.

Emerging Market central banks lagging developed counter-parts in cutting rates

In contrast, major Emerging Market (EM) central banks have, with the exception of Bank of Korea and Banco Central de Chile, kept their policy rates unchanged in the past fortnight.

In Non-Japan Asia (NJA), the Bank of Korea delivered a 50bp in inter-meeting rate cut (to a new record low of 0.75%) on 16^th March, joining the ranks of Indonesia and Malaysia which each cut their policy rates 25bp on 20^th February and 2^nd March, respectively. In the greater scheme these rate cuts have been modest, in line with our view that “the overall pace and magnitude of [central bank] policy rate cuts in Non-Japan Asia will be modest.” (see Asian central bank policy rates – Scalpel not knife, 7^th February 2020). In Emerging Europe, Middle East, Africa and Latin America major central banks have kept their policy rates on hold, with the exception of Banco Central de Chile which cut its policy rate 75bp to 1.00% on 16^th March.

As a result our measure of the EM central bank policy rate – a GDP-weighted average of nominal policy rates in 20 major EM economies – has been cut only 4bp so far in March and 21bp year-to-date (see Figure 1) albeit to a new multi-decade low of about 4.3% (see Figure 2).

There are at least four possible, non-mutually exclusive, explanations in our view as to why EM central banks have on the whole refrained from following in the footsteps of developed central banks in aggressively cutting their policy rates in the past couple of weeks.

1. They are not convinced that policy rate cuts are the best way to deal with the current economic fall-out;

2. They think that policy rate cuts in developed economies will deliver an economic boost to their economies (via lower debt repayment costs for example);

3. They cut their policy rates quite forcefully last year and in early 2020 and want to see how these rate cuts feed through to domestic growth and inflation before embarking on another round of sustained rate cuts (see Asian central bank policy rates – Scalpel not knife, 7^th February 2020). To put it in perspective, we estimate that the EM global central bank rate was cut by about 78bp between mid-2019 and end-January 2020, more than twice as much as the developed central bank policy rate
(-37bp). The other way to look at it is that developed central banks in the past fortnight have effectively been playing catch up with their EM counterparts.

4. They are concerned that further rate cuts will exacerbate capital outflows and put further downward pressure on their currencies and upward pressure on already high and/or rising headline CPI-inflation. Our GDP-weighted measure of EM headline CPI-inflation rose 165bp in the 12-months to January to an eight-year high of 4.4% (see Figure 3). January is the last month for which CPI-inflation data are available for all major EM economies.

Over that period the EM central bank policy rate was cut 88bp, resulting in a sharp 250bp fall in the real (ex-post) policy rate to a 102-month low of about zero (see Figures 4 & 5). Even before the coronavirus epidemic became a headline story EM central bank interest rate policy was already stimulative and inflationary, in our view.

Moreover, since January the EM central bank policy rate has been cut further, albeit by a modest 16bp (see Figure 1), while most EM currencies have weakened – resulting in an outright loosening of overall monetary policy. Figure 6 shows that only the Romania Lei, Taiwan Dollar and Chinese Renminbi Nominal Effective Exchange Rates (NEERs) have appreciated since year-to-date, according to our estimates. In broad terms, high-yielding, Latin American and currencies of oil-exporting nations have weakened the most while NJA and European currencies have weakened the least.

Financial markets, faced with a once-in-a-generation sell-off in global equities and acute volatility, are seemingly turning a blind eye to macro data releases, or at most only giving them a cursory glance. However, EM policy-makers are likely still paying attention to inflationary developments to the extent that high and/or rising inflation eats into consumers’ real purchasing power and could in time cause a loss of market confidence, exacerbating capital outflows and domestic currency pressures.

Some EM central banks may have scope for “catch-up” policy rate cuts

With this mind the next obvious question is which EM central banks have the room to cut their policy rates near-term and “catch up” with developed central bank policy rates. There is of course no blanket answer for all EM economies covered given the multitude of factors which individual central banks take into account when setting domestic policy rates. However, as a rule of thumb we think that EM central banks with a high real policy rate (in absolute and historical terms) and stable or appreciating currencies are more likely to cut their policy rates in coming weeks.

On the basis of this admittedly simplified metric:

• Central banks in India, the Philippines and Taiwan seemingly have the room to cut policy rates. Their real policy rates were still positive as of February at respectively 2.9%, 1.2% and 1.6%, according to our estimates, and the Indian Rupee and Philippines Peso NEERs have been broadly stable since end-2019 while the Taiwan Dollar has appreciated about 1% and (see Figure 7).

• Central banks in Brazil, Mexico, Russia and South Africa have positive real rates but their currencies have been under acute pressure in recent months which in our view reduces the scope for policy rate cuts.

• However, the South African Rand NEER has been broadly stable in the past six sessions (see Figure 8). If this remains the case in the next two trading sessions we think the South African Reserve Bank will cut rates from 6.25% at its policy meeting which concludes on 19^th March. 

• The National Bank of Poland’s real policy rate is amongst the lowest of any major EM economies (-3.2% in February) but the Polish Zloty has been reasonably resilient in relative terms. The NBP Management Board on 16^th March publicly stated that it supported the recommendation of NBP President Glapiński to cut the policy rate (currently at 1.5%).