TOPIC OF THE WEEK: Monetary policy gets into a more predictive easing mode
This past week was characterized by a host of monetary policy decisions in the Caucasus and Central Asia. The central banks of Armenia and Georgia cut policy rates as broadly expected while monetary authorities in Uzbekistan kept the policy rate unchanged. Next week it will be Azerbaijan’s turn to act while Tajikistan has one final rate decision this year, scheduled for late October.
The key takeaway from these decisions is that policy easing has now become more firmly established across the board, with the obvious exception of Azerbaijan, where we expect to see the first rate cut over the next two quarters. Those countries where the conduct of monetary policy can be best described as inflation targeting, including Armenia and Georgia, have tended to be more cautious in starting the cutting cycle given their desire to build credibility and guard against policy mistakes. However, both central banks have now made a series of rate cuts, putting them on the road of gradually converging to their neutral nominal rates over the course of the next two years.
On the other hand, Uzbekistan and Tajikistan already initiated their transition to easing last year, although there are very different end points in terms of their paths to rate neutrality. Tajikistan, which is already done with easing, is now running the policy rate at its estimated neutral level, and we expect the combination of robust growth and accelerating inflation to lead to rate hikes next year. Uzbekistan is undergoing significant relative price changes, which will ensure a much more extended period of closing in on its neutral policy level.
While monetary easing will continue relatively unabated in the months to come, making it more predictive in nature and more programmatic to forecast, we see two challenges for policy makers. First, the strong correlation between oil prices and inflation in these economies will ensure that the ongoing rise in the former will increase the volatility of the latter, creating some analytical challenges for central bankers in setting rates lower. Second, the very robust GDP growth rates seen in the past year or so are now starting to face increasing headwinds as the upcycle becomes more mature. This, on the other hand, will argue for bolder rate reduction. In combination, while we feel reasonably confident that monetary easing will proceed into this year and next, the path to lower rates may be bumpier than now foreseen.
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