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Expansionist trend continues, but not in Latin America

July 4, 2016

The highlight has been announcements from the world’s main central banks of a more supportive monetary policy.

In June, monetary policy decisions were made in 22 of the 31 countries we monitor.  Four central banks – Taiwan, Russia, South Korea and Indonesia – cut interest rates.  Latin America continues to swim against the global tide. Colombia’s central bank continued to raise rates, and Mexico surprised with a 0.50 percentage points hike, in a response to significant currency depreciation. Brazil’s central bank held the Selic benchmark rate stable and continued to signal that there is no room for interest rate cuts in the short term.

The highlight this month has been announcements from the world’s main central banks of a nor supportive monetary policy, following the Brexit. The Fed, in particular, signaled that interest rate hikes are unlikely in the near future. In our view, the world’s main central banks will maintain or increase monetary stimulus to avoid the possibility of tighter financial conditions, given the increased political and economic uncertainty in the European Union.

In this context, we do not expect interest rate hikes in Latin America during the second half of the year. The region’s balance of risks for inflation continues to improve, with less pressure on exchange rates, given the stabilization in commodity prices and expansionary monetary policy in advanced economies.

 


 

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 – Convergence in 2017

The Central Bank’s monetary policy committee (COPOM) maintained the SELIC rate at 14.25% in its June meeting, as expected. The highlight was the 1Q Inflation Report publication. The Copom sees progress in the fight against inflation, but it emphasized that continuing progress depends on the evolution of fiscal adjustments, among other factors. Inflation forecasts suggest convergence to the reference scenario but stabilized above the target in the market scenario. Hence, the committee underlined inflation convergence to the target in 2017, and it indicated that, given current conditions, there is no room for reducing interest rates. In our view, the situation will evolve to allow rate cuts in the second half of the year, but the Copom may need more time before it has the confidence to initiate the process.

The Copom believes that the external environment remains challenging and that “global activity has shown a trend of greater moderation” since its previous Inflation Report.

In Brazil, the committee understands that “aggregate demand will remain moderate in the relevant time frame,” maintaining the outlook for a disinflationary output gap. The committee also affirmed that monetary policy, as it must, is curbing the secondary effects of shocks to the exchange rate and relative prices. In that sense, the report concludes that progress has been made in the fight against inflation.

The Copom stressed, however, that for such progress to continue, further adjustments will have to be approved and implemented, particular on the fiscal front. Other factors influencing progress will be weather effects on food prices and uncertainty in the global economy.

Forecasts in the Inflation Report suggest a gradual decline in inflation in the reference scenario (constant exchange rate and interest rates), reaching 4.7% in 2017 and 4.2% (below the mid-point target) in 2Q18. However, forecasts in the market scenario (exchange rate and interest rates in line with market expectations) do not indicate convergence to the target. In this scenario, in which interest rates drop to 13.44% in 2016 and to 11.25% by YE17, the estimate for the IPCA inflation stabilizes at around 5.5% starting in the second half of 2017.

In the report – the first one under Ilan Goldfajn as Central Bank Governor– the Copom reaffirms its intent to adopt “needed measures to ensure inflation convergence to the 4.5% target in 2017.” Given this goal and the situation outlined in the document, the Copom repeated that the “central scenario does not allow one to work with the assumption of easing in monetary conditions.”

During the press conference after the report was published, Governor Goldfajn re-emphasized the message of pursuing the mid-point target in 2017. Goldfajn indicated that it is possible to create the conditions such that inflation forecasts also begin to recede in the market scenario, approaching the target center by 2017. He stressed that this will depend on, among other factors, the success of the fiscal adjustment currently underway. Regarding the external outlook, Goldfajn emphasized that the outlook remains challenging, particularly after Brexit. He mentioned that the short-term effects of the shock tend to be contained by global central bank actions, but, over time, Brexit should mean lower global growth.

We stand by our assessment that economic conditions will evolve to allow lower interest rates in the second half of the year. But today’s report suggests that the Copom may need more time than projected in our scenario (in August) before it starts cutting the Selic rate.

 

CHILE – Low likelihood of additional rate hikes

As unanimously expected, the central bank of Chile left its policy rate unchanged at 3.5% in its June meeting. The central bank has been on hold throughout 2016, following a short and discontinuous tightening cycle in 4Q15.

As foretold in the 2Q16 Monetary Policy Report (IPoM), the press release announcing June’s decision signals the central bank will likely remain on hold for a prolonged period of time. The IPoM signaled the next rate hike would possibly occur between the close of 2016 and the start of 2017.  

We continue to expect the central bank to remain on hold at 3.5% throughout this year and the next. As consumer prices continue to decelerate towards the target range, aided by a stabilization of the currency and a widening output gap, the central bank is unlikely to resume the tightening cycle.

 

COLOMBIA – Finalizing the tightening cycle

The central bank increased the policy rate by 25 basis points, as was widely expected, extending the tightening cycle to 3 percentage points and taking the policy rate to 7.50%. In the press conference that followed the announcement, Governor Uribe revealed that the decision was not a unanimous one.

The tone of the press statement do not clearly signal that the cycle is over. However, at the press conference following the meeting, Governor Uribe stated that the tightening cycle has been successful, helping keep inflation expectations around 4% (the upper bound of the central bank’s 2%-4% target range). He added that inflation remains at high levels, but that the central bank anticipates a significant slowdown ahead, while the economy is adjusting in line with expectations. Meanwhile, Cardenas said the “task is done” and that the policy rate has reached a suitable level, that will allow inflation to meet the target range by the end of 2017.

We do not expect any further rate hikes this year. We anticipate inflation will decelerate towards the target range as the effect of transitory shocks (El Niño and exchange-rate depreciation) unwind and internal demand weakens. However, further hikes cannot be ruled out, particularly if inflation surprises to the upside in the coming months, threatening a rise in inflation expectations.

 

PERU – The central bank stayed put in June, with a more neutral tone

The Central Bank of Peru (BCRP) decided to maintain its policy rate at 4.25% – as widely expected by the market (11 out of 12 firms, as per Bloomberg) – against the backdrop of lower headline inflation, lower inflation expectations and a stronger currency.

While the central bank maintains the tightening bias in the statement, we do not expect more rate increases in Peru this year or in the next. As inflation remains on a declining path and inflation expectations show signs of stabilization, the central bank is unlikely to resume the tightening cycle. The fact that the central bank is again purchasing dollars to curb the appreciation of the currency also signals that the bank is comfortable with the inflation outlook.

In fact, in the most recent inflation report, the outlook for inflation turned more benign. The central bank now expects inflation to converge back to the target range (1%-3%) before the end of 2016. Thus, the center point of the inflation forecast for 2016 was lowered from 3.3% to 3%, while the forecast for 2017 remained unchanged, at 2.1%. In the report, the central bank stresses the full reversion of food supply shocks (stemming from El Niño), a stronger exchange rate and lower inflation expectations. This is in sharp contrast with the previous report, when the central bank warned about the risks of second-round effects that could emerge from de-anchored inflation expectations and the pass-through from a weaker currency.     

 

MEXICO – Improving the carry

Mexico’s central bank raised the policy rate by 50 pp, in line with our call and above market consensus (25 pp, as per Bloomberg). The move was a response to the performance of the exchange-rate, the key variable driving Mexico’s monetary policy decisions. The Mexican peso has been one of the worst-performing currencies year-to-date and since May 5 (when the last monetary policy decision was held).

In the statement announcing the decision, the central bank emphasized the financial risks related to the Brexit. The central bank sees negative consequences of this event to global economic growth and to international financial markets. In this context, the board sees the need of preserving the macro fundamentals of the country, through fiscal consolidation and a tighter monetary policy. Although the board praised the recent fiscal consolidation announcements, it said more is needed, calling for a primary surplus from 2017 on.

In its concluding remarks, the central bank continues to mention first the evolution of the exchange-rate, when listing the variables to be monitored for the next meetings. Also identical to the previous decisions, the interest rate differential with the U.S. and the evolution of the output gap are listed.

Importantly, in contrast with the February hike, this time the central bank did not say “the move is not the beginning of a cycle”, leaving the doors open for more.

Considering that we see moderate growth this year, well-behaved inflation and no hikes by the Fed this year, we expect additional interest rate increases in Mexico in 2016 only if exchange-rate depreciation pressures return.


 

4. Calendar of monetary policy decisions in July


 


 



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