This week 11 central banks took policy decisions with Indonesia becoming the third emerging market central bank to raise rates this year while three banks cut rates (Ukraine, Belarus and Mozambique) and seven kept rates steady (Russia, Japan, Iceland, New Zealand, Korea, Philippines and Peru).
Indonesia’s rate hike was significant because it underscored the determination of central banks in emerging markets to combat inflation and their readiness to take on financial markets and avoid any semblance of economic instability
Brazil has already raised rates twice this year to push down inflation while Egypt raised its rate in March, arguing that high inflation will do more damage to the economy in the medium term than the temporary impact on growth from a rate rise.
Prior to Indonesia’s rate rise, central banks across emerging markets – including Poland, India, Turkey, South Korea, South Africa and Sri Lanka – had relied on words and actual market intervention to curb recent exchange rate volatility.
Bank Indonesia said its 25 basis point rate rise was a pre-emptive move to rising inflationary pressures and aimed at maintaining economic and financial stability at a time of increasing uncertainty in global financial markets.
Indonesia's rate rise seems to have taken markets by surprise though it came just two days after the central bank raised its overnight deposit rate to ease the pressure on the rupiah. Last month the central banks also warned that it would not hesitate to adjust policy rates and was closely monitoring inflationary pressures from the government's plan to cut fuel subsidies, which will push up inflation.
Emerging markets have been swept up in an outflow of capital in recent weeks, with stock markets falling, domestic interest rates rising and currencies slipping, especially those of Indonesia, Thailand, India, South Africa and the Philippines.
There were already signs of a change in global sentiment in early May, but the testimony by U.S. Federal Reserve Chairman on Ben Bernanke on May 22 seems to have convinced some major investors to suddenly shift their global portfolios.
Bernanke’s statement that the Federal Reserve could start to “take a step down” in the monthly purchase of $85 billion in assets “in the next few meetings” was seen as a sign of the coming shift in U.S. monetary policy and markets immediately priced-in a total stop in quantitative easing.
Ample global liquidity through quantitative easing and very low U.S. interest rates has cut the cost of holding risky assets, such as emerging market assets and stocks, and the sudden re-pricing of risk has hit global markets hard.
But the shift in sentiment and capital flows may be overdone.
Unlike the 1980s and 1990s, when a tightening in U.S. monetary policy lead to financial crises in emerging markets, most emerging markets are on a much more solid economic and financial footing today, with domestic demand the main driver behind economic growth in most countries.
And even if the Federal Reserve at some point will start to taper its asset purchases, it is a long way away from actually tightening short-term interest rates as economic growth is still weak and likely to remain so for some time.
The prospect of the shift in global capital flows away from emerging markets was a major theme for central banks this week, with both Chile and South Korea commenting in their policy decisions.
The Bank of Korea, which had been faced with the competitive disadvantage of a rising won against the yen following the Bank of Japan’s launch of more aggressive policy easing, said the possibility of an earlier-than-expected tapering of U.S. quantitative easing had lead to fall in the won and higher long-term rates.
The BOK added that possible change in U.S. monetary policy and fiscal consolidation in major countries amounted to downside risks to global growth.
The Central Bank of Chile, which also saw its peso fall in recent weeks, noted that global financial conditions had turned more restrictive, especially for emerging economies, ”in part due to the expectation of an early withdrawal of monetary stimulus in the United States.”
The Central Bank of the Philippines, which has been cutting the rate on its special deposit account in recent months to discourage foreign banks from parking there money there, took the opportunity of a drop in the peso to hold those rates steady.
The Reserve Bank of New Zealand, which intervened earlier this year in an attempt to curb the unrelenting rise in its dollar since March 2009, said its currency remained overvalued though it acknowledged that it had fallen in recent weeks.
This week’s surprise rate cut came from Mozambique, which concluded that inflation had now recovered after taking a hit from flooding earlier this year that affected agricultural output. It was therefore time for the Bank of Mozambique to return to its planned alignment of interest rates to economic growth.
The other two rate cuts came from Ukraine and Belarus. With Belarus cutting its refinancing rate by 150 basis points to 23.5 percent, it has ceded the top spot in global policy rates to Malawi and its rate of 25.0 percent.
Through the first 24 weeks of this year, central bank policy rates have been cut 57 times, or 25 percent of the 230 policy decisions taken by the 90 central banks that are followed by Central Bank News, steady from last week.
The number of rate increases this year rose to 12, marginally up to 5.2 percent of all policy decisions from last week’s 5.0 percent.
Central banks in emerging and frontier markets each account for four of the rate rises, central banks in other markets account for three while Denmark remains the lone central bank in developed markets to have raised rates, but this was purely for currency reasons and not a reflection of inflationary pressures or strong economic growth.
LAST WEEK’S (WEEK 24) MONETARY POLICY DECISIONS:
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NEXT WEEK (week 25) features nine scheduled central bank policy meetings, including India, Namibia, Morocco, Turkey, Georgia, the United States, Switzerland, Norway and Egypt.
In addition, markets will be focused on the Monday/Tuesday meeting by Group of Eight (G8) leaders at Lough Erne, near Enniskillen, Northern Ireland. A source told Reuters this week that the leaders are likely to discuss the role of central banks and monetary policy.
The G8 comprises the United States, Canada, Japan, Russia, Germany, France, Italy and the United Kingdom, which currently holds the rotating presidency.
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