Snapshot - Economics

Fed rate cut spurs EMs into action

A wave of rate cuts across the emerging markets is likely, as India joins Brazil in cutting interest rates by more than expected.

07.08.2019

Like Brazil last week, India’s central bank surprised markets with a larger-than-expected cut, easing by 35 bps to take the policy rate to 5.4%. The accompanying statement was also rather dovish in tone and suggested more cuts to come.

This month’s rate cut had been flagged at the previous meeting, the new governor’s first, which also delivered a rate cut.

Why has India cut rates?

While there is undoubtedly a political motivation for easing policy, the macroeconomic backdrop in India also warrants a softer stance at present. The central bank was able to point to weaker demand both globally and domestically, along with softer inflation.

Headline inflation in India remains below the 4% target, and core inflation is weakening. Core inflation excludes food and energy, which can be particularly volatile.

The central bank admits there are upside risks from food prices, particularly due to the effects of a subpar monsoon season on crop yields. But an above-target inflationary surge seems unlikely.

Helpfully, household inflation expectations are declining and corporates expect an easing of output prices. This has allowed the central bank to project inflation remaining in its target range over the next 12 months.

What does this mean for wider emerging markets?

More broadly, the start of Federal Reserve (Fed) easing seems to have been the firing gun for more aggressive easing across emerging markets (EM). We would expect more rate cuts across the region for as long as the Fed retains a dovish stance, particularly given the policy space central banks enjoy in EM.

One risk is the escalation in the trade war and the accompanying weakness in risk assets, including EM currencies. This may make central banks pause, but ultimately we expect ongoing easing from the Fed and elsewhere to spur their EM counterparts on.

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