Itaú BBA - CBs in advanced economies maintain stimulus in September

Global Monetary Policy Monitor

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CBs in advanced economies maintain stimulus in September

October 4, 2016

In September, central banks in US, Japan and Europe maintained monetary stimulus.

In September, there were monetary policy decisions in 28 of the 33 countries we monitor and the global trend remains expansionary. Three countries increased stimulus. Both Argentina and Russia cut their benchmark interest rate. The central bank of Turkey reduced its upper interest rate range for the seventh consecutive month. Moving in the opposite direction, Mexico’s central bank (Banxico) hiked rates by 50 bps due to the significant currency depreciation.

The highlights were the monetary policy decisions in advanced economies. The European central bank maintained stimulus and reinforced its decision to continue monitoring the Brexit impact on regional activity. In the United States, the Fed remained on hold, however three members voted to hike rates. In its statement, the committee acknowledged that the case for a rate increase has strengthened, particularly with stronger labor market conditions. We expect the Fed to raise interest rates in December, following the presidential election. Japan’s central bank (BoJ) maintained interest rates in negative territory and increased the flexibility of its asset purchase program, setting a target for the 10-year interest rate, which should float around zero.

In Latin America, monetary policy stance is becoming more expansionary. Brazil’s monetary policy committee is carefully setting the stage for an easing cycle. This outlook is reinforced by inflation projections disclosed in the 3rd quarter Inflation Report, which were at the target for 2017 and below the target for 2018. We expect the CB to start an easing cycle in October. In Chile and Colombia, central banks held rates stable and are likely to maintain this stance moving ahead. In Peru, further rate hikes are also unlikely despite the fact there is still a tightening bias in statements announcing monetary policy decisions. In Mexico, we expect Banxico to mirror the Fed and raise interest rates by 25 bps in December. A Trump victory in the US elections could result in a faster and bigger rise in interest rates.


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 – BCB setting the stage for an easing cycle

There was no monetary policy decision in Brazil in September. The highlight was the 3Q Inflation Report (QIR) published by the Brazilian central bank’s Monetary Policy Committee (Copom). As we have previously noted, the Copom is carefully setting the stage for an easing cycle, and this communication drive saw another important step, with the release of the QIR. The report has traditionally been used by the Copom to present the analytical background for its policy decisions, and this QIR certainly achieves this goal. There are a number of important, useful, changes in the report's content.

The committee extended its forecast horizon until the end of 2018, covering the whole period for which we have targets set by the National Monetary Council (CMN). Moreover, in addition to the usual baseline (constant exchange and interest rate) and market-based scenarios, the Copom published estimates under two alternative, hybrid, scenarios, which have constant exchange rate and interest rates according to market expectations, and constant interest rate with the BRL following market expectations.

Importantly, in two of the four scenarios that the Copom presented, inflation forecasts for 2017 are at the 4.5% target, and in three of the four scenarios for 2018 inflation is at or below target (and is above target by just 10bps in the other one). Faced with this set of forecasts an inflation forecast targeting central bank is bound to ease the policy stance.

The timing for the start of the easing cycle will depend, as previously stated by the committee, on three conditions: that short-run price shocks do not appear to be persistent, that we see progress on the fiscal reform/adjustment front, and also that service price disinflation proceeds at an "adequate" pace. The committee reckons that the food price shock is indeed passing, that there is progress, albeit still surrounded by uncertainty, on fiscal adjustment, but expresses caution about the disinflation of services - although a text box included in the report seems to indicate that slow and somewhat erratic service price disinflation may be due to the behavior of a few specific items that have been influenced by one-off sport events (World Cup and Olympics), methodological changes (domestic workers' pay), or state-level tax changes (some telecommunication services).

We think residual uncertainty about the pace of service price disinflation is unlikely to be totally erased until the Copom meeting, which would work against expectation of a bold (50bps cut) movement. Moreover, if the Copom begins with a 50bps cut and subsequent events suggest disinflation becomes less uncertain, market expectations might migrate towards even faster easing, which the committee probably does not want to deliver - in sum, starting with 25bps and then accelerating to 50bps seems to be the best option.

A cut in October is not a totally done deal, however, as the authorities will certainly be monitoring Congressional discussion and vote on the expenditure ceiling proposal, and a setback could push back the timing of easing. But with help on the fiscal adjustment front, the Copom will probably feel confident enough on the inflation outlook to start an easing cycle next month.

In summary, our call remains that the Copom cuts its base rate by 75bps this year, starting with 25bps in the October policy meeting.


CHILE – Not ready to cut, yet

As unanimously expected, the board of the central bank of Chile unanimously opted to hold the policy rate at 3.5% in September and retained its neutral stance, adopted in the previous meeting. The board has kept the policy rate stable throughout 2016, following two 25-bp rate hikes in 4Q15.

The central bank sees inflation evolving in line with expectations. Meanwhile, the relevant inflation expectations over a two-year horizon remain anchored to the 3% target. Activity, on the other hand, is still weak, hindered low private sentiment and a loosening labor market, in line with the 3Q16 Inflation Report (IPoM) forecast scenario.

We expect the central bank to stay on hold for the remainder of the year and throughout 2017, in line with the central bank’s baseline scenario. Recent surveys of analysts and traders also reveal the expectation of a prolonged maintenance of the policy rate. However, we acknowledge that given the fragility of activity and the expected disinflation ahead, the possibility of rate cuts cannot be ruled out. In fact, the minutes of the meeting showed that the option of rate cuts was already considered a valid option for analysis.


COLOMBIA – Unanimously on hold

The board of the central bank of Colombia unanimously voted to remain on hold at its September monetary policy meeting. This is the second month the board has left the policy rate unchanged, at 7.75%, after a 325-bp tightening cycle. Additionally, this is the first unanimous decision since the first rate hike in September 2015. The central bank adopted a neutral stance for the time being, as the press release indicated the board is in a wait-and-see mode to decide on changes to the monetary policy.

The central bank sees the Colombian economy adjusting to the terms-of-trade shock. With regard to domestic activity, the central bank acknowledges downside risks to activity in the second half of the year. The losses caused by the truck strike that took place between June and July means growth could come in below the central bank’s 2.3% forecast for 2016. Itaú is currently expecting a 2.0% expansion this year.

The board highlighted the moderation in inflation and inflation expectations. Because the market was negatively surprised by consumer price inflation last August, inflation expectations for the one- and two-year horizons fell to 4.35% and 3.61%, respectively (versus 4.6% and 3.7% previously). The disinflationary process is helped along by the fading out of supply-side shocks that affected food prices and a more stable currency than in the previous two years. The central bank also noted the favorable current account adjustment in the first half of the year.

In the absence of surprises, we expect the central bank to remain on hold for at least the reminder of this year. As Finance Minister Cárdenas recently said, rate cuts in the short run are unlikely for a number of reasons. First, inflation is still elevated, and inflation expectations are showing inflation would barely reach 4% by the end of 2017, as committed to by the central bank. Second, the expected tax reform could generate upside potential for inflation, especially due to the anticipated VAT increase. Finally, we believe a change in the current monetary policy stance would only come after key members of the board (including Governor Uribe) are replaced between the end of this year and the beginning of the next, following the conclusion of their appointments.


MEXICO – Hiking rates to protect the currency

In September, Mexico’s central bank raised the policy rate by 50 bps (from 4.25% to 4.75%). The decision was triggered by the sharp depreciation of the Mexican peso, which had been previously emphasized in Banxico’s official communications as the main factor in future monetary policy decisions.  

In the statement, the board explicitly cites the electoral process in the U.S. and its potential negative consequences for Mexico. More specifically, the rise of Trump in the U.S. presidential polls has been associated with strong depreciation pressure on the peso. 

The central bank continues to list the exchange-rate evolution as the key variable for upcoming decisions. The interest-rate differential with the U.S. and the output gap are also listed as significant variables, as before. However, September’s statement conveys a more conservative tone by specifying that the latest hike is not the beginning of a tightening cycle. This is in contrast with June’s statement, when the central bank also hiked rates by 50 bps but refrained from making this qualification (indirectly suggesting that further rate action was more likely). In addition, the central bank made the disclaimer that it doesn’t have a target for the currency.

Rate hikes ahead – dependent on the Fed and on the evolution of the currency – are still likely, but the board seems less happy with its current reaction function. In fact, what began as a one-off move to support the peso became a norm this year, and there is a limit on how much monetary tightening the central bank can deliver to support the peso without meaningfully hurting activity and actually deviating from textbook inflation targeting. 

We expect the central bank to raise the policy rate by 25 bps in December, together with the Fed. Our monetary policy rate forecasts for 2016 and 2017 are 5% and 5.5%, respectively (assuming the Fed delivers two 25-bp hikes in 2017). Granted, further hikes in response to exchange-rate weakening cannot be ruled out, but they are less likely than before.


PERU – Central bank has a more benign inflation outlook

The Central Bank of Peru (BCRP) published its third-quarter Inflation Report, signaling more optimism over inflation dynamics. The highlight is the lowering of the inflation forecast for 2016 (to 2.8%, down from 3%), which is in line with our call that the BCRP is gradually moving toward a neutral stance. During the presentation for local economists, Chief Economist Adrián Armas stressed that inflation expectations are now standing within the target range (1%-3%) for all surveyed years (2016, 2017, 2018), which he referred to as the “BCRP’s comfort zone.” Moreover, the official report states that the balance of risks for inflation is neutral, and that deviation risks have moderated with respect to the previous report.   

The outlook for economic activity remains sanguine. Growth forecasts for 2016, 2017 and 2018 are 4%, 4.5% and 4.2%, respectively. The BCRP expects a pickup in domestic demand in 2017 and 2018, driven by private investment, which would offset the moderation of natural-resource output. However, the recovery of private investment in 2016 (falling year over year for 10 consecutive quarters up to 2Q16) might take a little longer than the central bank expected. In fact, the BCRP lowered its forecast for private investment in 2016 to -4.3% (from -1%), which is offset in the baseline scenario by stronger exports and public spending relative to the previous scenario (leaving 2016’s GDP growth forecast unchanged at 4%).  

The explicit tightening bias – featured in official communications since August 2015 – is still present in the inflation report, but it will likely be removed sometime in the coming months. We note that BCRP policymakers seem increasingly more comfortable with the inflation outlook. Headline inflation rose above 3% in September, but this is attributable to a base effect that will reverse in the fourth quarter. Both the official forecasts and verbal guidance point to a neutral stance. We expect the BCRP to hold the policy rate at 4.25% in 2016 and 2017.


4. Calendar of monetary policy decisions in October


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