Inflation across emerging markets has fallen to its lowest level on record, but signs are emerging that the downward trend in price rises may have bottomed out and a 20-year cycle may be about to turn.
Since 1996, emerging market-wide inflation has plunged from 20 per cent to a record low of 2.5 per cent in July, according to data from JPMorgan, as the chart shows. Inflation in EMs is now just a percentage point higher than in developed markets, a fraction of the historic norm.
However, this week has seen a flurry of countries reporting a rise in inflation in August, including some that already had the highest rates in EM. Turkey led the way, revealing that consumer price inflation jumped to 10.7 per cent in the year to August, up from 9.8 per cent a month earlier.
In Mexico, inflation went up from 6.4 per cent to 6.7 per cent, an 18-year high. Inflation also rose in Taiwan (from 0.8 to 1 per cent), the Philippines (2.8 to 3.1 per cent) and Colombia (3.4 to 3.9 per cent).
China is expected to report an uptick in inflation to a seven-month high when it unveils August numbers on Saturday. The pick-up is likely to be starker in India, which is due to report August data on Tuesday, with Capital Economics pencilling in year-on-year inflation of 3.8 per cent, up from 2.4 per cent in July and 1.5 per cent in June.
While no one is expecting a return to the bad old days of rampant consumer inflation, with a few dishonourable exceptions such as Venezuela, there is a growing belief that the disinflationary trend has gone as far as it can, and may now begin to reverse.
“Headline inflation will bottom out in emerging markets. We are looking for things to gradually lift back up but stay on the low side,” said Joseph Lupton, senior global economist at JPMorgan. “Q2 was kind of the low point.”
Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman, added: “We are near or at the bottom [of the cycle], but I don’t see a take-off in inflation either.”
The long-run decline in emerging market inflation has been testament to a maturation of economic policy, with widespread adoption of orthodox monetary policy, flexible exchange rates and lower budget and current account deficits.
Inflation is still falling in Brazil and Russia, two countries that, despite suffering nasty recessions, have been willing to ratchet up interest rates in order to squeeze out spikes in imported inflation that resulted from a slide in their currencies.
Brazilian inflation fell to 2.5 per cent in the year to August, its lowest level since 1998, from 2.7 per cent in July. Russia saw a sharper decline, from 3.9 per cent to 3.3 per cent, meaning that consumer prices are now rising at their slowest rate since the break-up of the Soviet Union.
Food price deflation was the biggest driver of tumbling headline inflation in both countries, but the after-effects of their painful recessions are also still playing out in the shape of ample spare capacity.
“In both Russia and Brazil, two years of recession opened up an output gap so their economies can grow without opening up pricing pressures. Labour has lost its bargaining power,” said William Jackson, senior emerging market economist at Capital Economics.
But inflation is probably rising in enough countries now to counteract this. Turkey is exhibit A. This week’s jump in inflation was larger than most had expected, with core inflation, stripping out food and fuel prices, jumping to a 12-year high of 10.2 per cent, raising the possibility of both core and headline inflation remaining in double digits until the end of the year, according to Inan Demir, an analyst at Nomura.
Mr Demir attributed part of the jump to currency weakness — despite the lira, in common with most EM currencies, rising against the dollar this year, it has fallen 10.8 per cent against the euro.
On top of this, he argued that Turkey’s monetary policy stance, with benchmark interest rates of 8 per cent, “is not tight enough to contain domestic demand pressures”.
Mr Jackson agreed that the central bank “has failed to anchor inflation expectations”, although he saw the country as something of a distinctive case.
India’s inflationary rebound appears to be fuelled by a rise in vegetable prices — with heavy rains pushing up the price of tomatoes and onions — as well as rising core inflation, something Capital Economics expects to continue given high capacity utilisation rates.
Consensus forecasts, as measured by FocusEconomics, are for Indian inflation to average 4.7 per cent next year, twice the rate in the year to July, although Mr Lupton viewed this as a normalisation after a period of unusually weak inflation.
Fruit and vegetable price inflation, which hit 25.8 per cent in August, was also a big factor behind the jump in Mexican consumer prices.
Chinese inflation, just 1.4 per cent in the year to July, is also expected to drift up to 2.2 per cent next year, according to FocusEconomics.
Food price inflation is also a factor here, with Chang Liu of Capital Economics expecting a turn in the pork cycle, after 14 months of declines, alongside higher fuel prices and household rents.
His colleague Mr Jackson said China was one of several countries where food inflation “has come down a lot this year”, but that “some of the big falls in food inflation are probably now behind us and may start to reverse”.
With expectations of broadly flat core and fuel price inflation, this suggests that overall CPI inflation may now have troughed.
This trend may be accentuated in eastern Europe, where strong economic growth is leading to labour shortages and elevated wage inflation. In Romania, for instance, which was in outright deflation in 2015 and 2016, expectations are for inflation to rise from 1.1 per cent this year to 3 per cent in 2018, according to Foreign Exchange Consensus Forecasts.
Despite this, analysts still see scope for further monetary easing in emerging markets, particularly Latin America.
Brazil cut rates by 100 basis points to 8.25 per cent on Wednesday and market expectations are for a further 100bp of easing by December, according to Société Générale.
Colombia trimmed rates to 5.25 per cent last week, while Chile, which has already cut rates by 100bp to 2.5 per cent this year, could go further still next week, Mr Lupton forecasts. Peru, where rates are down 50bp this year to 3.75 per cent, may be in the same boat while, elsewhere, Russia and South Africa are both in easing mode.
The Czech Republic is a rare example of an emerging country that has tightened policy of late, having raised rates by 20bp to 0.25 per cent in early August. South Korea is one of the few Mr Lupton sees joining the Czechs in the new year.
“Most central banks are still in a dovish wait-and-see stance. I don’t think any of them are in a hurry to hike with all the risks out there,” said Mr Thin, despite tighter policy in the US and Canada.
“In the past we have had this one-to-one reaction for emerging and developed market rates, but we have seen a number of EMs easing rates even as the Fed is hiking, which was unheard of. It’s an experiment.”