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Central Banks on Hold, Except for China

September 2, 2015

Amid the turbulence in local markets, China’s Central Bank cut interest rates and the rate of reserve requirements.

There was monetary policy decision in 15 of the 31 countries we cover in August. The only change, however, occurred in China. Amid the turbulence in local stock exchanges and the announcement of a more flexible exchange-rate regime, China’s Central Bank cut interest rates by 0.25 pp and the rate of reserve requirements by 0.50 pp.

In Latin America, the expectation is for stable interest rates, but central banks are toughening their communications on concerns about the effect of FX depreciation on inflation. The weak economic activity, however, reduces the likelihood of a monetary tightening in the short term. In Brazil, this scenario is more severe, with a deepening recession and the exchange rate underperforming its peers, reflecting the domestic uncertainties. We expect Brazil's Central Bank to maintain interest rates flat for an extended period, despite the fact that the equilibrium in the country seems more unstable than that of other countries.


 

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 Signals Stable Interest Rates Ahead

There was no monetary policy decision in Brazil in August. Throughout the month, members of the Central Bank Monetary Policy Committee (COPOM) continued to signal a hiking cycle. The official communications state that the maintenance of the Selic rate at the current level of 14.25% for a "sufficiently extended" period of time is "required" for the convergence of inflation toward the target.

We expect the Selic rate to remain at 14.25% throughout the remainder of 2015. In 2016, inflation is likely to recede in response to the slowing economy and the end of the adjustments in public tariffs, which have lagged behind prices. In this scenario, we expect the COPOM to start an easing cycle in the second half of 2016.

There are risks to this path for the Selic rate. The exchange rate has been depreciating significantly, reflecting domestic as well as global uncertainties, which may require further short-term interest-rate adjustments. In fact, COPOM members have stated that "monetary policy must remain vigilant in case of significant deviations between inflation forecasts and the target."

MEXICO: A Split Board Left the Policy Rate Unchanged in July

The minutes of the most recent monetary policy committee meeting revealed a split decision to leave the policy rate unchanged, at 3.0%. The meeting was attended by only 4 of 5 members and one of them voted for a 25-bp rate hike (but we note that members normally identified as more hawkish were present at the meeting) as a preemptive reaction to the Fed's liftoff. Contrasting with the previous decision, only one board member was openly against raising rates before the Fed (instead of the majority). However, even this member discussed under which conditions a hike before the liftoff of the Fed would be advisable ("disorderly adjustments in the market"). This more conservative view is consistent with the message given by Governor Carstens recently: that rate hikes before the Fed could come depending on exchange-rate volatility. 

The majority of the board members warned on the possible consequences of the policy actions of the Fed to the exchange rate and the price dynamics in Mexico. The dissident argued that a hike in July would limit the uncertainty of the impact of the Fed's liftoff on inflation and financial stability in Mexico.  In addition, he argued that an adjustments post-Fed could imply a harsher policy response. Finally some members mentioned that policy actions are justified if there are concerns on financial stability, through the reduction of government securities by foreigners, even when inflation expectations remain stable. 

In all, the board remains highly concerned with the potential impact of the Fed's liftoff on financial stability and, to a lesser extent, on inflation, in spite of the weak activity and record low current inflation. We believe that rate hikes in Mexico will come only in 1Q16, after the Fed moves in December, once it becomes clearer that Mexico is benefiting from the U.S. recovery. However, if the exchange-rate overshoots, in anticipation of or together with the Fed's liftoff, rate hikes would come sooner than we are currently expecting.

CHILE: Hiking rates on the menu

The central bank unanimously held the policy rate at 3.0% in its August monetary policy meeting, but the minutes show that the board also debated a 25-basis point rate rise as a relevant option. This is the first time since October last year, when the previous easing cycle ended, that two options have been considered. By introducing a dual policy option, the board gains degrees of freedom to hike rates if necessary. The staff’s argument for a rate hike option is to ensure that inflation expectations remain anchored at the relevant two year policy horizon.

Including two alternatives in the policy discussion had the support of four of the five board members, with the fifth one believing the discussion of rate hikes was premature. However, two board members that considered the option of raising rates “quickly dismissed” this option. So it seems that, with the available set of information, the majority of board members are not ready to embrace a hiking cycle in the short term. The remaining two members noted that after a year-and-a-half of inflation above 4% and the expectation that it will remain there for the coming months, the central bank’s credibility could be at risk. One of them warned that reacting late to changes in expectations would ultimately be more costly. In his opinion, a rate hike was not currently appropriate as it would surprise the market. In the end, the board agreed that high inflation is due to transitory factors (namely, the evolution of exchange-rate), backing the decision to stay on-hold.

We currently expect the central bank to remain on-hold this year and the next, but risks for rate hikes are rising. The central bank remains in an unwelcomed position, with weak growth, on the one hand, and persistently high inflation, on the other. It is now up to the central bank to decide whether to hike in order to prevent inflation expectations from rising, or act only if the deterioration of expectations materializes. The latter poses the risk of a harsher response vis-à-vis a preemptive cycle.

COLOMBIA: Still on-hold

Colombia’s central bank left the policy rate unchanged at 4.5% in August, completing a full year on hold, but Governor Uribe said that the decision was not unanimous (as was the case in July). In the statement announcing the decision, the board kept a neutral tone, but we know from last month’s minutes that within the board there is a tightening bias. The central bank still sees the high inflation figures as a consequence of transitory factors (exchange-rate depreciation and supply-shocks impacting food prices), but it acknowledged that inflation could take longer to converge to the target due to the direct and second-round impacts of these transitory factors.

In the central bank’s view, inflation expectations derived from asset prices and surveys remain anchored, even though they rose recently and are sitting in the upper half of the 2%-4% target range. Governor Uribe highlighted in the press conference that expectations are “well-controlled.” Apart from the assessment of anchored expectations, the board sees the “likely spare capacity” as a contributor to inflation’s convergence to the target. So, the board considers the deceleration to not only be structural.  

We continue to expect the central bank to remain on-hold both this year and the next. But, considering that some board members are already willing to hike and that inflation expectations could become unanchored due to the sharp depreciation of the Colombian peso, the probability of rate hikes in the near future is non-negligible.

PERU: Policy rate held, but with a tightening bias

Peru’s central bank held the policy rate for the seventh consecutive month at 3.25% in August, but departing from recent decisions, the board adopted a tightening bias as it is increasingly concerned over the inflation outlook. While the current interest-rate level was still deemed compatible with inflation converging to the target range in the 2015-2016 horizon (as opposed to the 2% target-center stated in the previous decisions), the board indicated that they are actively monitoring inflation and inflation expectations to evaluate the necessity of rate adjustments to ensure inflation convergence.

As in the previous statement, the board explicitly mentioned the level of inflation expectations, which are sitting at the upper end of the 1% -3% target range. The board also commented that core inflation (excluding food and energy prices) has accelerated past 3% (the first time in six years).

All in all, the central bank is more concerned with the persistence of inflation at high levels and its impact on inflation expectations, in an environment of strong pressures for exchange-rate depreciation (due to the potential increases in the Fed Fund rate, uncertainty over China and lower commodity prices). Besides the tightening bias, it is worth noting that the central bank hasn’t reduced the reserve requirement for local currency since June. We do not expect any policy-rate moves during the remainder of the year, or throughout next year, as the economy remains weak (the central bank itself acknowledges that growth is below potential) but risks of a rate hike are larger than those of further cuts.


 

4. Calendar of monetary policy decisions in September

* Source: Bloomberg


 



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