IMF's Gopinath sees 'sizeable' upside inflation risks, says markets too optimistic

he International Monetary Fund's no-2 official said on Wednesday she sees sizeable risks that inflation will remain high or accelerate in many emerging markets and urged central banks to keep monetary policies tight.

IMF First Deputy Managing Director Gita Gopinath told a conference hosted by the Central Bank of Brazil that markets were probably "too optimistic" about what it would take to bring down inflation in emerging markets.

"Despite encouraging signs, I am worried that price pressures seem entrenched in many economies and that upside inflation risks are sizeable," she said in remarks prepared for the event.

"Central banks must remain resolute in keeping policies tight and recognise that insufficient monetary tightening now may necessitate even more painful actions down the road," she said. That was a lesson learned from the high inflation period of the 1970s and it "very much applies today," Gopinath said.

She said fiscal restraint could support the fight against inflation by central banks and financial tools could improve tradeoffs in the event of pronounced financial stress, if judiciously used.

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

But these countries still faced "considerable downside risks" from monetary policy tightening in advanced economies, and conditions may get "significantly worse," she said. Rate hikes in the United States, for instance, had come with still-benign conditions, but that could change in the period ahead, she said.

Gopinath said she was less optimistic than markets about lowering inflation in emerging markets, given that it had been unexpectedly high and persistent, and often rose faster than expected, she said.

Inflation in services had been strong and policy tightening had not cooled labor markets significantly, with wage growth still robust in many emerging market economies.

She said several factors could be contributing to the stickiness of inflation, including pent-up demand from the pandemic, rotation of demand from goods to services, and a decrease in potential output and employment.

Given few historical precedents for inflation coming down from very high levels without a significant economic slowdown, Gopinath said "quite strong" labor markets and activity pointed to "considerable upward pressure on inflation."

She said companies might pass on higher costs instead of absorbing them into their profit margins, and that workers could demand payback for real wage losses. That meant the longer inflation stayed high, the harder it could be to bring it down, and the larger the contraction of output that would be required.

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