IMF’s Gopinath sees ‘significant’ upside risks to inflation, says markets overly optimistic

IMF's Gopinath sees 'significant' upside risks to inflation, says markets overly optimistic


WASHINGTON (Reuters) – No. 2 official said Wednesday she sees significant risks that inflation will remain high or accelerate in many emerging markets and urged central banks to keep monetary policy tight.

Gita Gopinath, the IMF’s first deputy general manager, told a conference hosted by Brazil’s Central Bank that markets were likely “too optimistic” about what it would take to reduce inflation in emerging markets.

“Despite encouraging signs, I am concerned that price pressures appear to be entrenched in many economies and that upside risks to inflation are significant,” she said in remarks prepared for the event.

“Central banks must remain determined to keep policy tight and recognize that insufficient monetary tightening may now necessitate even more painful actions,” she said. That was a lesson learned from the high inflation period of the 1970s that “is very applicable today,” Gopinath said.

She said fiscal restraint could support central banks’ fight against inflation and financial instruments could improve trade-offs in the event of pronounced financial stress, if used judiciously.

Gopinath said emerging market economies have maintained growth in recent years, aided by strong monetary policy frameworks and reforms that had reduced credit and currency risks.

But these countries still face “significant downside risks” from monetary policy tightening in advanced economies, and conditions could get “significantly worse,” she said. For example, interest rate hikes in the United States had been accompanied by still favorable terms, but that could change in the coming period, she said.

Gopinath said she was less optimistic than markets about lowering inflation in emerging markets, as it has been unexpectedly high and persistent, often rising faster than expected, she said.

Inflation in the services sector was high and policy tightening had not significantly cooled labor markets, while wage growth remained robust in many emerging market economies.

She said several factors could contribute to inflation’s persistence, including pent-up demand due to the pandemic, rotation in demand from goods to services and a decline in potential output and employment.

Given the few historical precedents for inflation coming down from very high levels without a significant economic slowdown, Gopinath said “quite strong” labor markets and activity indicated “significant upward pressure on inflation”.

She said companies could pass on higher costs rather than include them in their profit margins, and workers could demand reimbursement for real wage losses. That meant that the longer inflation remained high, the more difficult it could be to bring it down, and the greater the contraction in output that would be required.

These challenges are global, but the risks are greater for emerging markets, Gopinath said, underlining that authorities in these countries must continue to strengthen their monetary, fiscal and financial policy frameworks.

(Reporting by Andrea Shalal in Washington; editing by Sam Holmes)