Key EM central banks set to loosen policy despite Fed hike

The Fed’s decision to raise interest rates this week has created ripples rather than waves among EM central banks. Policymakers in China and Turkey followed by tightening policy too, but this was as much to tackle domestic problems as it was to address external vulnerabilities or currency considerations. Interest rates in China are likely to be raised further in response to domestic credit risks but our sense is that the tightening cycle in Turkey has probably now run its course. Stepping back, the key point is that the Fed is no longer the driver of EM monetary policy that it once was. Most EMs now have flexible exchange rates, dollar debt burdens are relatively low and current account deficits have narrowed in recent years. This allows EM central banks to set policy according to domestic factors, which in most cases now point towards monetary loosening rather than tightening. Our interest rate diffusion index shows that more EM central banks have cut interest rates than raised them so far this year and this is likely to continue over the course of 2017.