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Easing bias remain in emerging markets

June 2, 2017

Brazil, Chile, Colombia and Peru cut interest rates, while Mexico hiked rates again.

In May, there were monetary policy decisions in 22 of the 33 countries we monitor. Countries that cut monetary policy rates were Brazil (by 100 bps, in line with expectations), Chile (by 25 bps, while the policy rate was expected to be maintained), Colombia (by 25 bps, in line with the consensus) and Peru (by 25 bps, in line with our expectation, while consensus expected stability). On the other hand, the Mexican central bank opted for another 25-bp hike, in line with expectations.

The central banks cutting policy rates continued to outnumber the central banks hiking rates. As a result, a large share of countries sustain an expansionary stance (14 out of 33).

In June, the main highlights are the monetary policy meetings in developed countries. In the U.S., we expect the Fed to implement an additional 25-bp hike. In the Eurozone, we expect the current stimulus to be maintained. The European Central Bank will likely indicate that risks to the outlook are balanced and withdraw the signaling of lower rates, but will probably continue to indicate that measures will be adopted in case of worsening financial conditions. In LatAm, we expect Chile’s central bank to maintain the policy rate (as it recently signaled the easing cycle came to an end), while a 25-bp rate cut is likely in Colombia and in Peru. In Mexico, we expect another 25-bp rate increase.


 

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

ARGENTINA –Tightening bias remains

The central bank kept the monetary policy rate unchanged at 26.25% for the third consecutive time at its second meeting in May.The central bank had hiked the reference rate (7-day repo rate) by 150 bps on April 11 after beginning to tighten monetary policy in March, through interventions in the market for Lebacs. The tightening came in response to expected unfavorable inflation readings for April (which finally came in at 2.6% MoM and 27.5% YoY).

In its recent statements, the central bank notes that, according to estimates and high-frequency indicators, the process of disinflation resumed in May.As a result, the central bank has kept the policy rate unchanged, while maintaining a tightening bias (by reiterating that it is ready to act if necessary and that will seek to manage liquidity conditions in order to ensure the consolidation of the disinflation process).

While another rate hike cannot be fully discarded, recent inflation data will likely prevent further tightening.According to private estimates, inflation likely fell below 2% month-over-month in May. It will also be important to monitor the evolution of inflation expectations, which currently stands at 21% for 2017, exceeding the upper-bound of the inflation target set by the central bank for this year (12%-17%).

We believe that a clear trend of declining inflation is sufficient to warrant lower interest rates in the future, even if meeting this year’s target is unlikely. In this scenario, we expect the repo rate to fall to 22% by December.

 

BRAZIL –Pace of rate cuts maintained as expected, with signals of a slowdown ahead

The Copom cut the Selic rate by 100 bps to 10.25% p.a., without bias, in a unanimous and a widely expected decision.The committee signaled that the next move is probably going to be a 75-bp rate cut, that would take the Selic to a single digit for the first time since 2013.

The statement announcing the decision makes it clear that the main risk factor is the implementation of the reform agenda.The communiqué stresses that prolonged and elevated uncertainty on the reform process and on the economic adjustment (which probably refers to fiscal policy) is the main risk, with effects on the determinants of inflation that are not trivial to assess - but whose net impact is, judging from the overall tone of the document, probably inflationary in the board members view.

We expect Copom to cut the Selic rate to 9.5% p.a. at its July 25 and 26 meeting, bringing the base rate to 8% by yearend.The May statement emphasized that the recent increase in uncertainty about the reforms and adjustments hinders a faster reduction of estimates of the structural interest rate and turns this, too, more uncertain. In addition, the inflation forecasts presented in the document suggest that there are risks of a slightly higher terminal interest rate in 2017 relative to our forecast.

 

CHILE – Earlier than expected cut likely ends current cycle

In May, the central bank of Chile surprised most in the market by cutting the policy rate by 25 basis points for a second consecutive month to 2.5%.The cut came earlier than we were expecting - we believed the cut would only be implemented in June - and for nearly two-thirds of the market, according to Bloomberg as well as the majority in both central bank surveys prior to the meeting. Nevertheless, the lowering of the policy rate is in accordance with our call from late last year of a 100-bp easing cycle from the 3.5% starting point. In line with the view that the current cycle has ended (at least in short-term) is the removal of the easing bias in the press release communicating the decision. Hence, it is unlikely that the upcoming Inflation Report (June 5) forecast scenario includes guidance towards lower rates.

Our baseline scenario considers no further easing.However, activity is weak and inflation remains low, so the balance of risks are tilted towards lower interest rates.

 

COLOMBIA – Reverting to a 25-bps rate cut

The central bank of Colombia continued with the monetary easing cycle by cutting the policy rate by 25 bps, to 6.25%, at its May decision.The decision was in line with the majority of analysts surveyed by Bloomberg but less than the 50-bp expected by us. The decision was the seventh consecutive split vote, with four co-directors falling in the majority, while the remaining three members preferred a 50-bp cut. This meeting marked the arrival of José Antonio Ocampo to the central bank, returning the board to its full representation of seven members for the first time since the January meeting this year.

The press release announcing the decision does not vary significantly from the previous month (when a 50-bp cut was implemented).However, the removal of the reference to falling inflation expectations hints that the results from the central bank’s May survey, which showed an inflation expectation tick-up at all measured horizons following April inflation’s upside surprise to the market, was a key factor behind the return to the more conservative approach. The board notes that the risk of a further activity slowdown remains; therefore we believe that rate cuts remain the preferred course of action ahead.

We expect the central bank to continue lowering the policy rate, but the pace of rate cuts (potentially including pauses) remains data dependent.We see the policy rate ending the year at 5.5% (75-bp below the current level). Disappointing growth and declining headline inflation will be arguments for rate cuts, while the unfavorable behavior of core and non-tradable inflation measures will likely generate some caution.

 

MEXICO – Board members dissent on future path of rates    

The Central Bank of Mexico hiked the reference by 25-bps (to 6.75%) in May, in line with our call and surprising the market.The minutes of this meeting, published two weeks later, show that all board members decided to vote for tightening monetary policy with the purpose of “preventing contagion in the price formation process and anchoring inflation expectations” (in other words, avoid second-round effects). Likewise, all board members agreed that the balance of risks on inflation has deteriorated. Moreover, the “majority” acknowledged that the share of items in the CPI basket with inflation above 4% has continued increasing, although only “some” (that means 2 out of the 5 board members) argued that the inflation correlation across items has increased and the risk of second-round effects has intensified. So, bottom-line, May’s hike was largely about deteriorated inflation conditions.

Even though May’s decision was unanimous, there are contrasting views about the future path of monetary policy.The minutes revealed that “some” board members consider that, provided the absence of new inflationary shocks, Banxico is getting close to the end of the tightening cycle. Moreover, one of these board members argued that, given the substantial monetary adjustment carried out so far (375 bps since December 2015), Banxico must not necessarily match future U.S. Fed rate hikes with similar moves. We believe that the two board members are Governor Carstens and Deputy Governor Díaz de León. Recently, Díaz de León actually said during an interview that monetary policy should be loosened if inflation starts converging towards the target. On the other end of opinions, as shown in the minutes, “other” members believe that inflation must start to trend down before evaluating the possibility of ending the tightening cycle. One member, in fact, mentioned that given the high levels of inflation and impending Fed hikes, more rate hikes in Mexico are likely in the next months.

We expect Banxico to deliver two more 25-bp hikes in 2017 (with the next one in June, in lockstep with the Fed).There are balanced risks for our call: while the fact that some board members see the cycle ending soon increase the risks of only one additional 25-bp rate hike, the behavior of inflation may end up forcing the central bank to raise interest rates by a bit more than we are currently expecting.

 

PERU – To cut rates again in June

The Central Bank of Peru (BCRP) decided to cut the reference rate by 25-bps (to 4%) in April, in line with our call and surprising the market.The negative inflation surprise in April (-0.3% vs. market expectations of 0%), explained by falling food prices (which spiked in March due to El Niño), marked the beginning of the reversion of the supply/temporary shock. This, coupled with the stability of long-term inflation expectations (as per the last BCRP survey), were key facts in the Board’s decision framework.

Monthly inflation came in negative in May and coincident indicators for activity are not showing signs of improvement, so this makes another rate cut in June likely.The CPI fell 0.4% in May, on the back of lower food prices (unwinding of El Niño shock), bringing annual inflation down to 3% (from 3.7% in April). Importantly, the forward guidance in the monthly statement explicitly reads: “the Board is watchful of inflation and its determinants, especially the reversion of supply shocks, to loosen monetary policy in the short-term”.

In our view, the Central Bank will deliver at least one more rate cut in 2017 – probably in June – taking the policy rate to 3.75%, with a bias to do more rather than less.The problem for the Central Bank is that short-term inflation expectations are standing above the tolerance range around its 2-percent target. Moreover, long-term inflation expectations are hovering close to the upper bound of the tolerance range, and BCRP policymakers have expressed concerns about this issue. Interestingly, last week, the IMF published the preliminary statement of Peru’s 2017 Article IV report, and argued that fiscal policy should be the first line of defense to tackle the economic slowdown, while monetary should proceed “carefully […] monitoring inflation expectations for any signs of persistent drift”.


 

4. Calendar of monetary policy decisions in June



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