Inflation rates are coming down across the Emerging Markets (EMs) and are now entering a second phase, Capital Economics said in a note on November 28. Central Banks are getting ready to cut interest rates but as inflation remains high 2024 could see these on hold in many markets.
"Following a temporary reversal in Q3, EM inflation has started to fall again in the last few months. While this is set to continue, we think it marks the start of a second phase in the EM disinflation process – one that will be characterised by a much more gradual grind down than seen in the first half of the year. This will leave inflation above target in many EMs for some time. As a result, while the EM easing cycle looks set to broaden out, policy interest rates will remain above neutral throughout 2024 in several places,” Leah Fahy, assistant economist at Capital Economics, said in a note.
Inflation in emerging markets had been on a sharp downward trajectory since the end of 2022, when price rises hit two-decade highs in many places.
Prices soared unexpectedly in the third quarter of this year, primarily due to idiosyncratic price shocks, including a surge in Indian inflation triggered by rising vegetable prices in July and a mini-inflation cycle in Brazil, reports Capital Economics. But more recently, EM inflation has resumed its decline as part of a broader downward trend. A measure of EM headline inflation fell from 4.6% year on year in September to 4.4% y/y in October, with core inflation also continuing its descent, says Capital Economics.
“Nonetheless, we think that the sharp falls in headline rates seen this year are largely behind us, for two key reasons. First, the fall in fuel inflation – one of the key drivers of disinflation – has run its course. Our oil price forecast suggests that EM fuel inflation will be steady. And second, strong wage pressures in Latin America and Emerging Europe will limit how far core inflation falls,” says Fahy.
The new phase of disinflation is expected to proceed at a slower pace. In Central and Eastern Europe there is room for further declines in headline rates in 2024, albeit less significant than in the previous year.
In Latin America, inflation is anticipated to recede gradually in the coming quarters. Meanwhile, the potential for further disinflation in Asia appears limited, given that inflation peaked at lower rates in that region.
“We think headline inflation rates will remain above central banks’ targets by end-2024 in most EMs, excluding Emerging Asia. What’s more, the risks are probably to the upside. El Niño is a key one, particularly in Asia; if dry weather decreases crop yields, this could put upwards pressure on food prices. And there could be a renewed spike in oil prices if the conflict in the Middle East escalates,” says Fahy.
In light of these factors, despite the expected expansion of the EM monetary easing cycle in the coming months, interest rates are likely to decline at a slower pace than anticipated, says Capital Economics. For regions outside Asia, policy rate forecasts generally exceed consensus estimates, suggesting that rates will remain above neutral in most EMs by the end of 2024.