EM central banks under pressure to hike rates on US Fed’s decision 

PHILLIP ISAKPA IN LONDON, UK

Analysts say central banks across emerging markets (EMs) are increasingly coming under pressure to raise policy rates in the wake of the decision last Wednesday by the United States Federal Reserve to hold rates at their two-decade high.

In Nigeria, the economy remains buffeted on several fronts with headline inflation rate rising 1.50 percent to 33.20 in March, the highest in 28 years, leaving the Central Bank of Nigeria (CBN), little to no room but to continue with its tightening policy.

Investors from around the world have been waiting anxiously for signals from the US Fed to open the gate for the much expected cut in interest rates to begin, but this has not happened owing to a lack of a clear signal from inflation data, and the economy remaining strong amid the strengthening of dollar.

Ahead of the sixth consecutive Fed meeting last Wednesday, analysts in London told Business a.m. that the rise in the Federal Reserve’s primary inflation gauge, the core PCE (personal consumption expenditures) price index, to 2.7 percent, above expectations of 2.6 percent, meant it was very unlikely a rate cut would happen.

“The latest reading from the Fed’s preferred gauge, PCE, underscores how inflation remains hotter than previously expected, despite the high interest rates which are being used as a weapon to try and cool it. With the US economy defying expectations by consistently remaining strong, with a strong labour market, rising PPI and CPI, and with today’s PCE, among other recent data, we are now revising our rate cut forecast,” said analysts at a financial advisory and asset management firm.

Last week’s decision by the Fed to keep rates high at a range of 5.25% to 5.5% is being interpreted by analysts to have implications for investors around the world with potential to affect various asset classes and regions.

The current Fed rates are two decades high and were first implemented last July 

​“This puts the squeeze on emerging-market central banks – including countries like South Africa, India and Mexico – to hike their own rates in order to address currency depreciation, inflationary pressures, capital flight risks, and external debt servicing concerns, ” said Nigel Green, chief executive officer and founder of deVere Group, one of the world’s largest financial advisory and asset managers, in a note to Business a.m.

He has warned that should policymakers move to raise rates in emerging economies, global investors could be impacted.

“Higher interest rates in emerging markets can lead to higher yields on government bonds issued by these countries. This is likely to attract foreign investors seeking higher returns, resulting in increased demand for emerging-market bonds. 

“In turn, higher yields may also lead to capital outflows from developed markets as investors reallocate their portfolios to take advantage of better returns in emerging-market bonds,” the deVere CEO observed.

A warning has also gone out about the potential impact on equity markets in countries that would be pressured to raise their rates. 

“Sectors that are sensitive to interest rates, such as financials and utilities, are likely to benefit from higher rates due to increased profitability; while those that rely on debt financing, such as real estate and consumer discretionary, will face challenges as borrowing costs rise, potentially impacting earnings and stock prices.

“These shifts influence investor sentiment and risk appetite and could lead to fluctuations in equity markets beyond the emerging economies,” deVere Group said in an analyst note.

The analysts also observed that any decision by emerging-market central banks to raise interest rates would also impact currency markets by influencing exchange rates and currency values. 

“Higher interest rates in emerging markets will attract foreign capital inflows, leading to appreciation in the local currency. 

“This affects currency pairs globally, as changes in exchange rates between emerging-market currencies and major currencies like the US dollar can impact trade flows, corporate earnings, and cross-border investments,” notes deVere Group.

Green observed that emerging markets are significant consumers and producers of commodities such as oil, metals, and agricultural products, and warned that higher interest rates could dampen economic growth and demand for commodities in emerging markets, leading to lower prices. 

“Conversely, a stronger local currency resulting from higher rates may decrease the cost of imported commodities, mitigating inflationary pressures and supporting consumer purchasing power,” he added.

Over time, it has become clear that nearly all the officials of the Federal Reserve, including chairman Jerome Powell, have said they don’t expect to start cutting rates until they see more evidence that inflation is headed in the right direction and back towards the 2% target.

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