The EM Tightening Cycle Begins Amid Continuing DM Dovishness

  • With price pressures building up globally and public debt loads historically high, policymakers will seek to balance concerns about inflation against efforts to support the recovery while keeping public finances on a sustainable path. 
  • Unlike in developed markets (DMs), concerns over the feed-through impact of rising inflation on staples, especially food, have prompted emerging market (EMs) monetary authorities to reverse their hitherto dovish bias and start tightening, although only gradually. Given that this will be a gradual adjustment, Fitch Solutions expects that EM interest rates will remain very low by historical standards in both 2021 and 2022. 
  • The pace of policy normalization will be significantly slower in DMs. Fitch solutions expects that most central banks will only start raising interest rates between 2023 and 2024, even though risks to their view have shifted to the upside due to rising inflation, implying the possibility of hikes in 2022. 
  • Developed markets’ central banks will retain an ultra-dovish bias through to 2022 to support the economic recovery as policymakers have expressed a willingness to tolerate above-target inflation for a time in order to support growth. They also believe that output will remain below pre-pandemic levels in many DMs in 2021. Among the top eight DMs by the end of 2021, only Australia and the US will be bigger than they were before COVID-19. 
  • Fiscal deficits are expected to narrow in 2021 but will remain far wider than pre-crisis levels due to concerns about choking off the recovery in the event of a premature tightening of fiscal policy.

(Source: Fitch Solutions)