Central banks in emerging markets are spearheading a new wave of interest rate hikes, moving decisively faster than most developed-economy central banks that are still assessing the economic fallout, as renewed conflict in the Middle East reignites global inflationary pressures.
Since the outbreak of hostilities in the Middle East in late February, at least ten central banks in emerging and frontier markets have raised their policy rates. Notably, within the last two weeks, the monetary authorities of Indonesia, Rwanda, South Africa, and Sri Lanka have all tightened policy. In contrast, policymakers in the United States, the Eurozone, Japan, and Canada have held steady to evaluate the economic impact of the conflict, with Norway and Australia being among the few developed economies to have already increased rates.
Lauren van Biljon, a senior portfolio manager at Allspring Global Investments, noted that these rate hikes reflect "policymakers' desire to protect their hard-won credibility." She pointed out that emerging market central banks are drawing lessons from the previous global tightening cycle. During that period, many acted ahead of their developed-market counterparts to combat post-pandemic inflation, and they have subsequently shown more caution in cutting rates as price pressures eased.
The ongoing Middle East conflict has severely disrupted shipping through the Strait of Hormuz, a critical artery for global energy and commodity supply chains. The resulting supply shock has driven up the prices of energy, fertilizers, and food, complicating the inflation outlook for central banks worldwide. In response, governments are adjusting their policy stances by pausing or reversing monetary easing measures, implementing energy price caps, and cutting fuel taxes.
The situation in the region remains volatile and uncertain. Recent reports indicate a series of retaliatory military actions between Iran and the United States, with both sides issuing conflicting statements about the outcomes of strikes on military assets. Furthermore, diplomatic exchanges between Iran and the U.S. regarding a memorandum of understanding have reportedly been paused for several days, a claim denied by U.S. officials.
Another critical driver for the rate hikes by emerging market central banks is the need to support their domestic currencies and stem capital outflows, with more central banks expected to follow suit. The Reserve Bank of India has pledged to crack down on speculation against the Indian rupee and is reportedly considering a rate hike this week. The Bangko Sentral ng Pilipinas has indicated it may consider an outsized, off-cycle rate increase ahead of its scheduled policy meeting on June 18.
However, the aggressive measures taken to bolster currencies have yielded mixed and often fleeting results. Following a surprise 100-basis-point hike by Sri Lanka's central bank on May 22, the Sri Lankan rupee initially strengthened but has since weakened again. Similarly, the Indonesian rupiah briefly firmed after a surprise 50-basis-point hike in late May before falling back to hit a new record low.
Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB, observed, "There's a limit to how much central banks can support the exchange rate. The real problem is that these emerging markets are highly dependent on imported oil. Global energy supply and prices are not something central banks can control, so they are in a bind."
A private wealth management head at UOB Kay Hian in Singapore added, "Rate hikes cannot solve the oil import bill problem." He noted that a genuine recovery for currencies like the Philippine peso, Indonesian rupiah, and Indian rupee will ultimately depend on a decline in oil prices, not on the rate hikes themselves.
The pressure to tighten monetary policy is also extending to developed economies. The U.S. Federal Reserve, European Central Bank, Bank of Japan, and Bank of England are all scheduled to hold policy meetings this month. While the market widely expects the Fed to hold rates steady this month, traders remain defensively positioned, continuing to bet on a Fed hike later this year.
Inflation in the Eurozone has risen above 3% for the first time in two and a half years, solidifying expectations that the ECB will raise rates at its meeting next week. The UK's weak economic performance is causing hesitation at the Bank of England regarding further tightening. The Bank of Japan is widely anticipated to raise its benchmark rate by 25 basis points this month, bringing it to 1%.
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