EM inflation: Higher, more entrenched

Marcelo Carvalho, Luiz Peixoto, Jeffrey Schultz

We are increasing our EM 2022 inflation forecast by 4pp to 10% due to rising energy and food prices, trade disruptions and renewed supply-side constraints, resulting from the Russia-Ukraine conflict. 

Our inflation forecasts rise most for CEEMEA, due to large increases for Turkey and Russia, but also in CE4. 

In Latam, our 2022 inflation forecasts see significant rises for Colombia and Mexico. 
In Emerging Asia, we note meaningfully higher CPI rates after a history of low inflation and fiscal subsidies. 

EMs are highly sensitive to price changes in food and fuel costs, our VAR and salience exercises indicate, leading to more entrenched inflation pressures.

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Commentary by Jeff Schultz, senior economist at BNP Paribas South Africa:

The ongoing war in Ukraine we believe will continue to have severe, longer-lasting implications for global supply chains, commodity prices and global inflation

Many emerging markets, already facing problematic inflation dynamics prior to the conflict, now face even more acute challenges for inflation expectations and their monetary policy reaction functions.

Our latest EM inflation update looks at these implications in more detail, with our team revising up our collective EM CPI estimates for 2022 by a substantial 4.0pp to average 10% this year.

While South Africa’s own inflation has, up to now, benefited from its own idiosyncrasies (large output gap, weak wages and unit labour costs) that have kept underlying inflation benign, we believe that one shouldn’t underestimate the dubbed “salience bias” in behavioral economics given the substantial price shocks the economy is about to face in fuel and food price increases (the latter two components making up a majority of lower income expenditure deciles).

Indeed our latest analysis shows SA as one of the standouts in food and fuel price contributions to CPI (adjusted as a ratio to their corresponding weights in the CPI basket) where these are likely to punch more than 6.5x their weight in the CPI basket over the next 12m – see table below. The risk of more problematic inflation expectations this year has therefore become more acute, in spite of powerful base effects in H2, where we now see scope for inflation to average 6.5% in 2022, up from our prior 6.0% estimate.

This week Thursday’s SARB MPC decision and statement we believe will prove an important segway into a SARB that is becoming increasingly uncomfortable with what looks to be a larger negative real rate outlook (see our preview here). While we don’t (yet) see the SARB raising rates by 50bp this meeting, front-loading more aggressive rate hikes (50bp) in coming meetings could well become the strategy as the SARB looks to nip inflation expectations in the bud and build up buffers against an increasingly uncertain global backdrop where (global) recessionary and stagflationary concerns could well come back to the fore later this year.

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