Emerging market inflation hits near-six-year high

Surging food prices have pushed emerging marketwide inflation to a near six-year high, reversing a disinflationary trend that has held sway in the developing world since the immediate aftermath of the global financial crisis.

A gathering wave of fuel price inflation, largely driven by base effects, is also likely to strengthen in the coming months, helping to keep broad headline inflation levels elevated.

At this stage, analysts are not expecting a turn in the monetary policy cycle in most emerging markets, where inflation and benchmark interest rates have tumbled in unison in many countries in recent years.

However, the jump in inflation may limit scope for further monetary easing in the likes of Mexico, South Africa, India, Brazil and the Philippines, as well as adding a hawkish tint to policymaking in eastern Europe.

Emerging marketwide inflation jumped to 4.6 per cent, year on year, in December, up sharply from 3.4 per cent in September, according to an index based on 62 countries (admittedly excluding Argentina and Venezuela where inflation is through the roof ) maintained by Capital Economics.

This is the highest reading since 2014, when oil prices were $110 a barrel, as shown in the first chart, even as price pressures remain exceptionally weak in the developed world.

“[There are] more upsides in headline inflation ahead,” in the developing world, said Kamakshya Trivedi, co-head of global foreign exchange, interest rates and emerging markets strategy research at Goldman Sachs.

“After a 2019 rich in downside inflation surprises across EM, in recent weeks innovations have been mainly on the opposite side, with some notable upside surprises in India, the Czech Republic, the Philippines, Poland and Turkey,” he added.

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Goldman’s inflation acceleration metric, which aims to capture momentum and base effects in 16 EM countries, and which the bank describes as a “reasonably good predictor of future changes in year-on-year inflation”, has jumped markedly after languishing at lows in September, depicted in the second chart.

The rise has largely been driven by a surge in food price inflation, which has jumped to an eight-year high of 8.2 per cent, according to Capital Economics.

The largest driver of this has been African swine fever, which has cut China’s pig herd by more than a third, with the estimated loss of 100m pigs, and has spread to central Europe.

This has pushed pork prices in China to record highs and rippled out more widely as China’s meat imports jumped 63 per cent in the first 11 months of 2019 from the same period the previous year to $16.3bn, according to customs data.

Brazilian meat prices, predominantly beef, for example, rose by 25.7 per cent year on year in December, up from 7.8 per cent in November, off the back of rising Chinese demand.

“That alone added 0.5 percentage points to the annual rate of headline inflation between early November and early December,” said William Jackson, chief emerging markets economist at Capital Economics, accounting for a large slice of the 1.2-point rise in consumer price inflation to 3.9 per cent.

Overall, meat price inflation across 14 major emerging markets is running at 33.5 per cent, according to an index constructed by the consultancy, illustrated in the third chart.

This will have more impact on overall inflation than in developed countries because of the higher weighting that food tends to have in CPI baskets in the emerging world.

Food price inflation has also been pushed higher by a spike in the price of vegetables in India, after severe flooding damaged crops.

Edward Glossop, emerging markets economist at Capital

Economics, believed that EM food inflation was “probably close to a peak”, with Indian vegetable inflation likely to start to ease after the first quarter of the year and signs that the disruption related to Asian swine fever is fading.

Chinese pork prices fell month on month in December for the first time since early 2019, with the annual inflation rate slipping from 110 per cent to 97 per cent, Mr Glossop said, a trend coinciding with a rise in both Chinese and Polish pig stocks.

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“That corroborates with comments from policymakers in China that they are getting to grips with ASF and stopping it spreading,” he added. “That suggests that the worst of the spread has probably happened. If pork prices are flat from here we should start to see a fall in yearon-year inflation quite sharply.”

One possible glitch could be the drought and bushfires in Australia, however, which have reduced cattle numbers.

Australia’s beef exports to China jumped 81 per cent in the first 11 months of 2019, according to Australia’s department of agriculture, although the country’s overall beef exports rose by just 7 per cent as its shipments were rerouted to China from other markets, such as Japan, Indonesia, Canada and the Philippines.

Capital Economics expects its headline measure of EM inflation to trend downwards from here. Nevertheless, Mr Glossop said inflation would actually rise further in most EM countries.

Firstly, higher oil prices are likely to push up inflation. As oil prices were generally lower in 2019 than in 2018, year-on-year fuel inflation was generally negative, dragging down headline inflation rates. However, yearon-year oil price differentials have recently turned positive, meaning they will push CPI inflation higher, not lower.

Mr Glossop estimated that Em-wide oil price inflation will rise from -4.5 per cent at present to +3 per cent, assuming that spot oil prices remain at current levels. This would be enough to push up overall inflation by half a percentage point.

Secondly, core inflation, which strips out food and fuel prices, may also rise in countries that have recently loosened monetary policy, such as India, where interest rates have been cut from 6.5 per cent to 5.25 per cent in the past year, while strong growth and labour shortages should keep inflation elevated in eastern Europe.

Given that much of the upward pressure is coming from noncore food and fuel prices, some central banks may choose not to react by tightening, or refraining from loosening, monetary policy.

As a generalisation, Mr Glossop said “more sophisticated” central banks in Asia, central and eastern Europe and Chile were more likely to look through such inflation.

However, some others, such as the banks of Colombia and Mexico, tend to be quite hawkish as elevated food and fuel prices have historically been more likely to have secondary inflation effects and to push up inflation expectations.

As a result, Capital Economics believes monetary policy in Mexico, as well as South Africa, will be tighter than many observers expect this year.

Further rate cuts in India may also be off the near-term agenda after headline inflation jumped to 7.35 per cent in December, from 5.5 per cent a month earlier, well above the central bank’s 4 per cent target, the consultancy said. Likewise, the recent pick-up in Brazilian inflation may stymie further policy easing.

Goldman Sachs said a jump in inflation in the Philippines, from 1.3 per cent in November to 2.5 per cent in December, significantly above consensus expectations, meant risks to its forecast of a further 50- basis points of policy easing were now skewed in a “more hawkish direction”.

The biggest differences may come in eastern Europe, however. Given that inflation in the Czech Republic has risen to a seven-year high of 3.2 per cent, above the central bank’s target range of 1-3 per cent, Goldman said the risks were “skewed towards higher rates in the coming months”, despite markets pricing in cuts in the next two or three quarters.

Likewise in Poland, where inflation jumped from 2.6 per cent in November to a seven-year high of 3.4 per cent in December, Goldman said any discussion of 2020 rate cuts, which the market had been pricing in, was now “off the table”.