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A more challenging environment for monetary easing in Latin America

December 5, 2016

In November, 18 of the 33 countries we monitor held policy decisions. In Latin America, the overall monetary policy stance is becoming more expansionary.

In November, 18 of the 33 countries we monitor held policy decisions. Brazil, New Zealand and Argentina cut interest rates. Conversely, Mexico and Turkey raised interest rates.

In Latin America, the overall monetary policy stance is becoming more expansionary. However, external uncertainties create a more challenging scenario for monetary policy in the region. In this environment, Argentina will continue to cut interest rates, but at a slower pace. If there is no additional volatility in global markets, we expect an acceleration of the pace of interest cuts in Brazil at the beginning of next year. Chile and Colombia are likely to start a monetary easing cycle in 2017. On the opposite track, we expect the central bank of Mexico to follow the Fed and raise interest rates by 25 bps this month.

In December, all eyes will be on monetary policy decisions in the U.S. and Europe. The Fed is likely to raise interest rates, while the ECB is likely to extend its asset-purchasing program.


 

1. Policy rates: Historical table

*Blank places mean absence of monetary policy decision for the month.

** Numbers in red indicate rate cuts, in green rate hikes and in grey another monetary policy change different from interest rates.


 

2. Charts


 

3. Monetary policy in LatAm

BRAZIL –Copom: paving the way for faster cuts

In November, the Copom delivered its second rate cut, another 25bps move, taking the Selic to 13.75%, in a unanimous vote.

The statement concedes that domestic activity has been disappointing in the near term, and notes that this disappointment has induced lower GDP forecasts for 2016 and 2017. The committee concludes that the recovery may be slower and shallower than previously anticipated.

Copom members noted that the external environment is “especially uncertain”, thanks, in our view, to the consequences of the US election surprise. The committee has doubts whether the external environment will remain benign, and attaches a high probability to a resumption of monetary policy normalization in the US.

On a dovish note, the committee concedes that inflation has surprised favorably, thanks to lower food prices, but that the process has become more widespread. In another factual update, the authorities acknowledge that inflation expectations for 2017 have fallen to 4.9%, from 5.0%, while those for 2018 and beyond are already at the 4.5% target.

Inflation forecasts considered by the committee were affected by factors that worked in opposite directions (exchange rate upward, activity, current inflation and expectations downward). They stand at 4.4% and 4.7% in the baseline and market scenarios for 2017 (from 4.3% and 4.9% at the previous meeting) and near 3.6% (reference) and 4.6% (market scenario) for 2018 (3.9% and 4.7% previously). These forecasts seem to be consistent with end-2017 rates near 11% - we expected them to be at 10%.

Risks around these inflation forecasts are balanced. To the upside, the committee cited (i) the possible end of a period in which the external environment has been favorable to emerging economies; (ii) signs that the pause in the disinflation of “some” IPCA components persists; (iii) uncertainty about the approval and implementation of needed (read fiscal) reforms. The Copom thus has downgraded its concern with the government´s (hitherto successful) reform efforts, while it has upgraded those with respect to the external environment. On the downside, (iv) weaker activity and wider slack may lead to faster disinflation; (v) favorable short term inflation prints may signal a less persistent process; and (vi) the needed adjustment process may be faster than anticipated.

Convergence of inflation to the targets in 2017 and 2018 is deemed to be consistent with “gradual” easing – no longer “moderate and gradual”, hinting at a potentially larger cycle than originally envisaged.

The magnitude of the cycle and, most interestingly, a potential increase in its pace, are said to depend on inflation forecasts and expectations, and the behavior of the cited risk factors. The Copom stresses that the pace of disinflation embedded in its forecasts may strengthen in case the economic recovery is slower and more gradual than anticipated – the committee was forecasting GDP growth of 1.3% in 2017 as of the September inflation report. The committee adds that such faster paced disinflation hinges on an adequate external environment.

Overall, the accompanying statement leaves the door open for an acceleration to 50bps, although it does not commit the Copom to deliver it. We reckon that, absent a strong positive surprise with activity, the Copom will move towards a faster gear, cutting the Selic by 50bps to 13.25% in its January 11 policy meeting, as long as we do not see additional stress in global markets.

CHILE – Case for easing gains traction

The central bank left the policy rate unchanged in November at 3.5%. The vote was unanimous and the central bank kept the neutral bias in the statement announcing the decision.  

The tone of the minutes shows that the case for an easing bias is gaining traction. The board is anticipating inflation forecasts will be adjusted down in the upcoming Inflation Report (IPoM), to be published on December 19.

Although the board agreed to stay on hold at the November meeting, the debate within the board raised the expectation for rate cuts in the future.Several board members saw recent data had led to a material change to the inflation trajectory (vs. 3Q16 IPoM), which increased the probability of monetary stimulus in the near-term. A further board member agreed, but noted that the possible adjustment would be small and not significantly different from that seen in asset prices (between one and two 25-bps rate cuts at the time). Moreover, one member went as far as saying that rates could be cut at the October meeting, but he favored not surprising the market.

As long as financial conditions for emerging markets do not deteriorate significantly further, we expect the central bank to start cutting rates in January.The easing cycle would come only after the central bank lays out its new forecast scenario in the 4Q16 IPoM. We see the policy rate at 2.5% by the end of next year, but consecutive rate cuts are unlikely. In fact, we do not expect the central bank to signal already in the upcoming IPoM the full easing cycle that we expect.

COLOMBIA – A divided board holds rates

The board of the central bank of Colombia voted to remain on hold at its November monetary policy meeting.It was the fourth month the board has left the policy rate unchanged at 7.75% after having implemented an extensive 325 basis points tightening cycle. However, it was the first time since the end of that cycle that some board members (2 out of the 7) opted for a rate cut. While the press release retained a neutral stance, we see the division within the board as evidence of a move towards adopting an easing bias and eventually embarking on a loosening cycle.

The unwinding of supply-side shocks affecting inflation continues to unfold at a faster than anticipated pace.In spite of this, the central bank points out that core inflation measures as well as one-year inflation expectations remain beyond the 2% – 4% target range.

We expect an easing cycle next year as demand-side pressures wane and disinflation continues.We see the central bank taking the policy rate to 6.0% from the current 7.75%. However, we do not expect rate cuts before there is clarity on the minimum wage adjustments and on the fiscal reform. Regarding the later, the central bank is focused on the inflationary impact from not approving the bill rather than the short-term inflationary impact of higher consumption taxes.

PERU – Shifting to neutral

After a mild and short tightening cycle (100-bps bwtween 3Q15 and 1Q16), Peru’s central bank has left its policy rate unchanged at 4.25%.The rhetoric has turned more neutral, as inflation and inflation expectations fell. Yet the monthly statements  still show an explicit tightening bias.

We expect the central bank to move entirely to a neutral stance, and maintain the reference rate at 4.25% throughout 2016 and 2017.In our view, rate cuts in 2017 are unlikely mainly because we expect domestic demand to pick-up. Moreover, recent developments – namely: higher U.S. treasury yields – will likely turn the central bank cautious, given the partial dollarization of the economy. At the same time, with inflation gradually converging to the target, rate hikes are unlikely.

MEXICO – Dealing with the “Trump shock”

The Central Bank reacted cautiously to Trump’s election, waiting for a scheduled meeting to announce a policy response and hiking the reference rate by 50-bps.Governor Carstens and Finance Minister Meade held a press conference on the day after the U.S. election, but there was no policy announcement. One week later, at November’s meeting, the Central Bank hiked the reference rate by 50-bps. In the statement, the board emphasized that the focus of monetary policy is on preventing “second-round effects from the currency weakening”, instead of “the evolution of the exchange rate, because of its pass-through to domestic prices” (as in previous statements).

The quarterly inflation report confirmed that the board’s attention is shifting from the Mexican peso’s depreciation to its second-round effects on inflation.The report stated that Mexico is facing real shocks (rather than just volatility), so a real exchange rate depreciation is necessary.  

Thus, episodes of currency sell-off (at least linked to protectionism risks) are less likely to trigger rate hikes automatically. At the same time, just like in the statement, the Inflation Report continued to mention that they will watch closely the short-term interest rate differential with the U.S. So hikes following the Fed (and by the same magnitude), which is our base-case, remains likely.

We expect Banxico to hike by 25 bps in December, assuming the Fed makes a similar move, and then deliver two similar hikes next year (also following the Fed), bringing the reference rate to 5.5% and 6.0% by the end of 2016 and 2017, respectively.

Central Bank governor steps down.Agustín Carstens presented a resignation letter to President Peña Nieto, and will step down from the Central Bank Governor position in July 2017. Thus, Banxico's board will experience some re-shuffle in 2017. Manuel Sánchez (one of the four deputy governors) will leave the board at the beginning of 2017, and has been replaced by Alejandro Díaz de León (CEO of Mexico's Foreign Trade Bank and former Chief Economist at Banxico). Díaz de León was appointed by President Peña Nieto. The successor of Carstens will likely be another technocrat with strong academic and professional credentials – just like every other member of the board – so we don't think there is a negative implication on the conduction of Mexico's monetary policy. Banxico has built a strong credibility over the past decades, which is reflected in the taming of inflation (significantly down from the 90s decade levels), well-anchored inflation expectations, and low exchange rate pass-through.


 

4. Calendar of monetary policy decisions in December


 

 



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