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Prospects Weekly: More developing-country central banks tightened policy than loosened it in July, Consumers are experiencing lower domestic food price inflation, Concerns about the second largest bank in Portugal did not change global risk perceptions

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To counteract inflation risks, more developing-country central banks tightened policy than loosened it in July. While external price pressures associated with past currency depreciations remain significant in some countries, the recent decline of domestic food price inflation in most developing regions should have a moderating effect. Market concerns about financial troubles in the second largest bank in Portugal have had limited international spillover effects, partly reflecting a general climate of low risk aversion.
 
Five developing-country central banks increased policy rates in July, outweighing rate cuts in other countries. Among these five countries, three (South Africa, Ghana and Ukraine) acted to mitigate inflation pressures linked to past currency depreciations, whereas in Egypt policy rates were hiked to pre-empt an expected rise in fuel costs in August (due to a cut in fuel subsidies), and in Malaysia to remove policy accommodation following signs of more self-sustained recovery. In contrast, central banks in Peru, Turkey and Hungary cut rates this month. In Hungary, the decision to ease policy appeared to signal an end to a 2-year cycle of interest rate cuts aimed at lifting demand and inflation from current low levels. Central banks in Peru and especially in Turkey lowered rates despite above target inflation, reflecting economic slack, expectations of more moderate inflation ahead and benign external financing conditions. The room for monetary policy accommodation is expected to gradually diminish for most developing countries as the U.S. Federal Reserve moves closer to its own tightening cycle (expected to start around mid-2015).
Consumers are experiencing lower domestic food price inflation across most developing regions since the start of the year. The recent slowdown was particularly marked in South Asia and Latin America, albeit from a higher level, as both regions saw double digit increases in domestic food prices throughout 2013. In Africa and East Asia, the deceleration was less pronounced, with food price inflation stabilizing during the first four months of 2014 around 6 and 3 percent respectively. In contrast, prices recently accelerated in Eastern Europe, mainly reflecting developments in Ukraine. Notwithstanding risks associated with a potential El Niño phenomenon later this year, further moderation in food price inflation would support domestic demand and contribute to restoring price stability in a number of middle income countries (such as Brazil or India). The slow pass-through of declining international food prices into domestic prices observed in many developing regions over the last two years notably reflect specific weather, currency developments, domestic cost pressures or trade policies.
Concerns about the second largest bank in Portugal did not change global risk perceptions. Banco Espirito Santo (BES), the only large Portuguese bank that did not receive capital injection during the country’s three-year bailout program, found itself exposed to escalating default risk of its parent holding company since early July. Market repercussions were significant in Portugal, with sovereign Credit Default Swap (CDS) spreads increasing by up to 80 basis points and the Portuguese stock-market initially losing 6 percent relative to other European markets. However, cross-border contagion effects were limited, as reflected in stable CDS spreads and bank stock valuations in other euro-area economies. Fears of broader spillovers were contained by the fact that BES’s difficulties were unrelated to the bank’s own operations, that capital buffers were available and fresh private capital was eventually injected (on July 23). It also reflected an overall climate of low risk aversion and continued search for yields, benefiting the demand for riskier assets from other euro-area economies. Beyond Europe, affiliate banks in Angola and Panama were affected through loan and capital exposures but confidence was so far maintained, as reflected in relatively stable currencies and sovereign spreads.

 

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