By Karin Strohecker

LONDON, (Reuters) – Emerging market central bank are likely to increase interest rates at a pace never seen in over a decade. This will exacerbate existing debt problems as well as hurt equity markets.

In response to high prices, rate rise expectations have increased even for Australian and British central banks. The rise in global borrowing costs that follows will not be welcomed by developing countries. Many are currently struggling to return their economic output to pre-pandemic levels.

Many emerging central banks, which are struggling to keep up with rising energy and food costs, have already initiated aggressive rate-hikes.

Money markets expect emerging markets to increase the pace of policy tightening as the United States and Britain have higher expectations.

Manik Narain from UBS’s emerging market strategy said that many emerging markets find themselves in an ever more difficult position. He cited expectations that the current inflation shock in emerging economies would be much stronger than it is in America or Europe. It’s difficult to balance the market pricing cycle, which is much more rapid in emerging markets than it is in developed.

(GRAPHIC: EM inflation overshoots targets – https://fingfx.thomsonreuters.com/gfx/mkt/klvykzxojvg/InflationAndRates.png)

JPMorgan (NYSE -) predicts that South Africa and Turkey, Mexico, Poland, Poland, and Turkey all will raise rates more than 200 basis point over the next twelve months. Latin America will experience the most significant increases. Brazil is forecast to increase by 600 bps while Colombia will rise by 400 bps.

The data shows that price pressures are outpacing interest rates in many big economies, including South Africa and Mexico. All regions have strong underlying inflation trends. Mexico’s core inflation experienced its greatest biweekly growth nL1N2RA1LX during the first half October 1999. Russia saw an inflation spike to nearly 8%, despite booming rate increases.

UBS’ Narain explains that with the droughts plaguing large agricultural producers, such as Argentina and Mexico, food inflation is on policymakers’ minds.

“If there is a lot more pressure on food prices than we are seeing, then policymakers will be in an extremely tight spot.”

(GRAPHIC: Emerging market inflation rates and forecasts for 2022 – https://graphics.reuters.com/EMERGING-INFLATION/zjpqkerzrpx/chart.png)

It is possible that money markets have become too extravagant. Barclays Christian Keller (LON) is the head of economics research and expects that both emerging and developed market central banks will offer fewer interest rates than price, however he cautioned that it’s when inflation expectations begin to decline that you should act as a bank.

EMERGING CONUNDRUM

The situation is an echo of an old dilemma facing emerging markets: tightening policy at the expense of extra support.

To keep foreign investors in the domestic market and to prevent capital outflows, it is important that there be a real yield difference over U.S. Treasury yields. A swift central bank intervention may have kept many emerging currencies stable in 2021 and helped to curb imported inflation.

In a year where the U.S. Dollar has appreciated nearly 5%, Brazil’s real has suffered a loss of more than 8 percent, supported by 575bps rate increases. However, the Brazilian real has managed to hold steady at 3.2% thanks to 325bps rate hikes.

Robert Ojeda Sierra at Fitch Ratings stated, “Hiking early helps with inflation but also helps to prevent a 2013 taper tantrum style situation, and certain central bank have gotten on board of this and saw their currency do okay.”

However, those markets have not adjusted their monetary policy sufficiently have suffered… has fallen more than 20% since this time.

(GRAPHIC: EM interest rate hikes priced in – https://fingfx.thomsonreuters.com/gfx/mkt/zjvqkwqwavx/Emerging%20market%20hikes%20priced%20in.PNG)

The majority of central banks agree that there is only one way to go.

Russia elected to raise its interest rate by 75basis points, but Elvira Nabiullina of the Central Bank had previously considered increasing it 100bps.

GROWTH HIT

However, if currency have not been affected by higher interest rates, it is still a problem elsewhere.

In 2021 emerging equities will be in trouble, as compared to the 20% plus gains made on the 16% rise of global stocks.

These pressures are likely to return, as the nominal growth rates of major emerging markets like Brazil and South Africa have fallen below interest rates.

The pandemic-era rise in debt costs will cause bond markets to experience higher borrowing costs, and more debt servicing. The local emerging debt index yields at JPMorgan have increased by more than 150 basis points in the past year.

While central banks may be ready to take action, the final outcome will depend on the speed at which the U.S. increases its interest rates. The pressures on the labour market will likely cause more tightening that those in energy and commodity prices.