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A delayed recovery and sticky inflation is miring the EM EMEA outlook

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

RAMYA RS
Analyst
DIFC Branch – Dubai
T:+971 (4)387 5031
E: ramya.rs@ae.mufg.jp

LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp

PAUL FAWDRY
Head of Emerging Markets FX Desk
Emerging Markets Trading Desk
T: +44(0)20 577 1804
E: paul.fawdry@uk.mufg.jp 

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Macro focus

Economic growth across EM EMEA economies has displayed surprising resilience in the past 18 months in the face of significant economic headwinds. However, growth appears to have slowed thus far in H2 2023, averaging 2.1% according to our nowcast models (see here). In the CEE region and South Africa, growth appears to be broadly stable at anaemic levels. In Turkey and Russia, it is weakening from relatively strong levels. Meanwhile, Saudi Arabia’s commitment to supporting oil prices at the expense of lower volumetric production will drag headline GCC growth down this year. In aggregate, we view that part of this slowdown is temporary, and reflects a global inventory cycle in the manufacturing sector. In addition, we expect the drag from last year’s tightening in global financial conditions to continue to ease. Meanwhile, given mixed inflation dynamics, we expect a significant divergence in policy rates over the next twelve months. In the CEE region and South Africa, we forecast a sharp decline in rates through 2024. Set against this, we expect further tightening in Egypt, Russia and Turkey.

 

FX views

It has been another difficult week for EM FX. The USD has extended it advance for the eighth consecutive week against other major currencies and it is continuing to place downward pressure on EM FX. Our equally-weighted EM FX index remains close to year to date lows against the USD. The National Bank of Poland has since followed by delivering a larger than expected 75bps cut last week. It has triggered a sharp sell-off for the PLN resulting in EUR/PLN moving back above the 4.6000-level for the first time since April. It marks an abrupt turnaround for EUR/PLN after it had been threatening to break below the 4.4000-level heading into the summer. The negative initial market reaction highlights that market participants are not convinced that the improvement in the inflation outlook in Poland justified such a large rate cut.

 

Week in review

In the last week, Poland central bank cut policy rates by a surprising 75bps to 6.00%, ahead of the October elections. August inflation slowed down further in the Czech Republic, while surprising to the upside in Russia and Egypt. South Africa’s Q2 2023 GDP came in positive, at 1.6% y/y, beating expectations and Turkey’s July current account deficit came in wider than expected.

 

Week ahead

In the week ahead, we have a rate meeting in Russia (MUFG +50bp to 12.50%; consensus on hold at 12.00%). August inflation data will be released in the Czech Republic (MUFG and consensus 8.5% y/y), Romania (MUFG 9.4% y/y; consensus 9.2% y/y) and Israel (MUFG and consensus 4.0% y/y). Beyond EMs, all eyes will be on the US inflation print for August with consensus expectations of a rise by 0.4ppts to 3.6% y/y.

 

Forecasts at a glance

In a world of tightening global financial conditions and questions about the liquidity implications of the now-finalised US debt ceiling, we see a degree of macro risks for EM economies in H2 2023, with external funding requirements the central concern. We expect EM growth to trough this year but remain below potential in the 2024 recovery. The silver lining is that subdued growth should cap inflation, facilitating monetary policy easing where external balances allow.

 

Core indicators

According to data from the IIF, EM Fund flows have slowed and in the week ending 1 September, EM funds recorded the fifth consecutive week of net outflows of USD1.6bn - USD1.4bn and USD0.2bn withdrawn from EM equity and bond funds, respectively.