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Prospects Weekly: Despite easing in May, gross capital flows were 14 percent higher in the March-May period compared to the three months preceding February

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Gross capital flows to developing countries have rebounded from the sharp dip in February. While flows look to have eased in May, they were 14 percent higher during the three months since February than during the three months that preceded the dip. Developing country inflation has eased recently, but remains high – influenced by very high rates in a few countries and sticky inflation in several middle income countries. Inflation has accelerated in the U.S and Japan, but remains weak in the Euro Area. The ECB announced an ambitious set of new easing measures this week (including reducing its benchmark policy interest rate and liquidity measures) aimed at fighting deflationary risks.  
Despite easing in May, gross capital flows were 14 percent higher in the March-May period compared to the three months preceding February. Following a strong rebound from the emerging market turmoil in late January and February, gross capital flows eased in May. Capital flows between March and May averaged $55 billion, 14 percent above the 3-month average of $48 billion prior to the February plunge. The May weakness likely reflects some payback from the very high flows in the preceding two months, as price indicators suggest continued appetite for developing country debt, partly reflecting very accommodative global financial conditions and search for yields (developing-country bond yields have declined by close to 150 basis points in recent months). Equity issuance was up slightly to $7.3 billion in May, in parallel with developing-country local stock markets gaining 3 percent during the month. Meanwhile, syndicated bank lending remained subdued in May and year-to-date volume is down 19 percent from the same period in 2013, a reflection of overall weakness in global syndicated loan activity amid the continued rise in loan funding costs since late last year. 
Developing country inflation eased to an annualized 6.2 percent in the three months to April (3m/3m saar) from 7.7 percent in January, but remained high in several middle-income countries. The decline mainly reflects lower inflation in China, which fell from 2 percent to just 0.6 percent, in line with slower growth, as well as a halving of inflation in the Middle East & North Africa (mainly due to the relaxation of sanctions in Iran). Stable commodity prices helped abate inflation among low-income countries, while policy tightening helped to ease inflation in Indonesia. But inflation remains high or ticked up in a several middle income countries reflecting pass through of earlier depreciation (Argentina, Turkey), but also capacity constraints (India, South Africa), drought (Brazil), and political instability (Ukraine, Venezuela). Food price risks related to El Niño weather conditions could push up developing country inflation. Quarterly inflation in high-income countries ticked up from 1.5 percent in January to 1.8 percent in April as domestic demand in the US firmed and a tax hike was implemented in Japan, but Euro Area inflation declined further in the context of pervasive spare capacity.

The European Central Bank (ECB) announced an ambitious set of new easing measures aimed at fighting deflationary risks. The package included: (i) a new 400bn euro (550 bn USD) targeted longer-term refinancing operations facility that allows banks to access ECB funding at 10 basis point (bp) above the main policy rate in proportion to increases in non-financial and non-household lending, and (ii) a further 10bp interest rate cut in the ECB's main refinancing to 0.15 percent and a cut to deposit rates that brought them into negative territory at -0.1 percent (a first for a major central bank). The ECB plans to accelerate preparations for securities purchases backed by loans to companies, notably small and medium enterprises. The package could have significant effects by: (1) ramping up liquidity provision to the banking sector; (2) discouraging banks from hoarding liquidity at the ECB; (3) encouraging lending to companies, and (4) putting downward pressure on long term yields and the euro exchange rate with reinforced forward guidance. Markets had already priced in a number of these measures, which contributed to a compression of global bond yields and a weakening euro since end-March.

Download the Prospects Weekly as PDF here.

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