Itaú BBA - Global trend remains expansionary, but Fed likely to hike rates in 2016

Global Monetary Policy Monitor

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Global trend remains expansionary, but Fed likely to hike rates in 2016

September 2, 2016

In August, monetary policy decisions were made in 19 of the 33 countries we monitor, and the global trend remains expansionary

In August, monetary policy decisions were made in 19 of the 33 countries we monitor, and the global trend remains expansionary.[1] Three countries, Australia, Argentina and New Zealand, cut their benchmark interest rate. The central bank of Turkey once again reduced its upper interest rate range. In the UK, the BoE fulfilled expectations when it cut interest rates by 25 bps but surprised the market when it increased its Quantitative Easing Program by 60 billion pounds. The bank’s more expansionary stance came in response to Brexit.

Another highlight last month were signals from members of the Fed that a rate hike could still come in 2016 as activity rebounds and financial conditions improve. August job figures in the U.S. support the view that the Fed has room to raise rates at least once this year.

In Latin America, monetary policy stance is becoming more expansionary. In Colombia, the central bank held rates and ended a cycle of monetary tightening. In Brazil, the Selic benchmark rate remained unchanged, but the central bank signaled that any future monetary policy easing would depend on how the data and events unfold, which, in our view, creates an opportunity to begin a cycle of interest rate cuts in October. In Chile, the central bank omitted the tightening bias from its official statement. In Peru, further rate hikes are unlikely despite the fact that there is still a tightening bias in monetary policy statements. We only expect future rate hikes in Mexico, as its central bank remains focused on the Fed and exchange-rate developments.

In September, all eyes will be on the central banks in advanced economies. The highlight will be the Fed meeting. Although our baseline scenario only includes an interest rate hike in December, we believe that asset pricing underestimates the likelihood of an earlier move this month. Other monetary policy meetings will take place in Japan, where the central bank will reevaluate stimulus tools, and in Europe, where a change in monetary approach is not expected.


 

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 – In data dependent mode

The Copom decided to leave the Selic unchanged at 14.25% pa in its August meeting, a unanimous decision. In line with our view, but unlike the market consensus, the committee decided to change the content of the policy statement in an important way, scrapping the sentence that unambiguously negated scope for monetary easing. The text lists, instead, a number of conditions on which monetary easing will depend. These are that we have limited persistence of foodstuff price shocks, that the IPCA components that are more sensitive to monetary policy and activity (read, services) show adequately paced disinflation, and that we see less uncertainty about the implementation and components of fiscal adjustment - tax induced price hikes would clearly be unhelpful on this front.

The statement shows more confidence in that domestic activity is stabilizing and might gradually recover, while still noting it operates with wide slack. On the external environment, the

Copom still envisages a benign period for emerging economies, despite doubts on global growth and, particularly, normalization of US monetary conditions - this last point is a factual update in reaction to recent Fed communication.

The committee adds that current inflation is still under (upward) pressure, partly due to food prices, that are retreating at a slower than anticipated pace - again a factual update. Importantly, the Copom notes that, while inflation expectations for 2017, captured by the Focus survey, remain above target, those for farther horizons, that were not cited in the previous statement, are already around the target - this is important, as it signals the committee is, as expected, starting to shift its gaze to said longer-end horizons.

The committee updated its forecasts, with a major upward shift in that for 2016, which reached 7.3% (in line with the current market consensus), compared with 6.8% as of the last policy meeting. In policy relevant horizons, that is, beyond 2016, the forecasts either remained relatively stable or fell, and for 2017 are around the target in the baseline scenario (constant exchange rate and interest rate) and at 5.1% (5.3% previously) in the market scenario. This is particularly relevant because the outlook for 2017, as captured by the Copom’s forecasting model, has improved, despite a higher expected starting point, and stronger inertia, from 2016.

On the balance of risks to inflation, the Copom repeats the three upward ones: (i) that currently high, foodstuff price led, inflation becomes persistent, (ii) uncertainty about approval and implementation of needed economic adjustment, and (iii) the fact that a protracted period of high inflation and above-target expectations could strengthen inertia, and adds a downside risk, in the guise of (iv) wholesale prices that suggest a weakening of the foodstuff price shocks, (v) faster economic adjustment, enhancing confidence gains and lowering inflation expectations, and (vi) the risk that economic slack leads to faster disinflation. The scorecard now is three upside and three downside risks to inflation - previously upward risks were winning 3X2.

In our view, while well short of committing to cut the Selic, the Copom in this statement clearly makes the next steps data and event dependent, and opened the way to start easing policy as early as in the next, October 18-19 meeting. We expect them to do just that, with a 25bps move, and that the Selic will end the year at 13.5% pa. Next, the release of the Copom meeting minutes next week.

 

CHILE – A looser stance

The central bank of Chile is unlikely to resume interest rate hikes anytime soon. The minutes of the August monetary policy meeting show the anticipation of a faster convergence of inflation than that envisioned in the 2Q16 Inflation Report (IPoM), due to the evolution of the exchange rate. In this context, the board of the central bank unanimously voted for the eighth consecutive month to leave the policy rate at 3.50%. The scenario also convinced most board members to drop the tightening bias in the communication, so there is now a neutral stance on monetary policy.

Furthermore, the minutes show that one board member deemed it necessary to include a rate cut as a valid alternative in August. This member disagreed with the staff’s recommendation to consider only the option to keep the rate unchanged. According to him, the flattening of the yield curve was not necessarily reflecting a more expansionary monetary policy, but rather responding to the perception of lower long-term rates, due to lower potential growth. The other board members were more cautious, with two of them preferring to wait until the publication of the 3Q16 IPoM before dropping the bias. One of them believed a more detailed explanation of the bias-change could be necessary to minimize the risk of conveying mixed signals to the market. Such a risk included the incorporation of rate cuts into the baseline scenario, something he believed would be incorrect in the current circumstances.

We expect the central bank to remain on hold for at least the remainder of this year and the next. With inflation returning to the target range, weak growth and well-anchored inflation expectations, rate hikes are unlikely. In fact, we think rate cuts ahead are more likely than hikes. However, given the long period of inflation above the target, the board is unlikely to consider this option before inflation has stabilized around the target.

 

COLOMBIA – Tightening cycle likely over

The central bank decided to keep the policy rate stable at 7.75% in August, interrupting an eleven-month 325-bp tightening cycle. The verdict was expected by most market participants, following a recent change in tone from various board members and a broad stabilization of inflation expectations. We expected the central bank to implement a 25-basis point rate hike considering that after the previous meeting, the central bank delivered a hawkish Inflation Report, acknowledging that there was less than a 50% chance that inflation would end 2017 in the 2%-4% target range (a commitment of the central bank). The press release announcing the decision revealed that the board voted 6-to-1 in favor of holding the policy rate (which compares to the 4-to-3 decision in favor of a rate hike in July).

As we expect annual inflation to start a downward trend in August, helped by the dissipation of the adverse impact of the El Niño and of the exchange rate depreciation, it is unlikely that the central bank will resume rate hikes soon. Barring an upside shock to inflation and inflation expectations, we expect the central bank to remain on hold for the reminder of the year, before engaging in a loosening cycle next year.

 

MEXICO – Unchanged policy rate in August, while the board monitors the Mexican peso and the Fed

Mexico’s central bank decided to maintain the reference rate at 4.25% - in line with our expectation and that of market consensus. The decision follows the 50-bp rate hike by the end of June.

In the board’s view, since the previous decision the balance of risks for activity deteriorated. Meanwhile following the latest rate hike, the balance of risks for inflation is now neutral. In the statement, the central bank mentions the recent weak activity data. Regarding inflation, the upside risks (mainly further exchange rate depreciation) offset the downside risks (weak activity and the impact of structural reforms on consumer prices).

Still, the focus of the central bank remains on the Mexican peso and the Fed. As it has been the case over the recent monetary policy decisions, the board continues to pledge that it will monitor in its upcoming meetings (likely in this order of importance): the evolution of the exchange-rate, the interest rate differential with the U.S. and the output gap. Also, it again mentions explicitly that given the possibility of new episodes of exchange rate volatility (due to the U.S. elections or higher interest rates in the U.S.), it is “crucial to reinforce the policies oriented to maintain the solid macro fundamentals of the country”. On the fiscal front, this means additional fiscal consolidation measures (which could also help to reduce the current account deficit). For monetary policy, it implies acting to keep inflation and inflation expectations well-anchored.

We expect Mexico’s central bank to raise interest rates again in December (by 25 bps), together with the Fed. Looking beyond 2016, we still see two additional rate hikes (of 25 bps each) in 2017, also in line with the Fed.

 

PERU – Gradually removing the tightening bias

The central bank of Peru (BCRP) decided to maintain its reference rate at 4.25% - in line with a unanimous consensus. The decision was taken against the backdrop of: lower inflation (back to the range around the target in July, after 16 months above the upper limit); lower inflation expectations; firm activity (we expect Q2’s GDP growth at 3.7% year-over-year); and a marginally weaker exchange rate than in the previous meeting.

Consistent with the recent developments on inflation, the statement shows the central bank is less concerned over the inflation outlook. The central bank notes that headline inflation is now running within the range around the target, whereas in the last meeting they expected this to happen before the end of the year. The second important change is that the inflation forecast for 2017 was lowered - from 2.1% (as per the official forecast in Q2’s inflation report) to 2%. Finally, the central bank continues to mention that inflation expectations are on a downward trend, but now it also stresses that expectations stand within the range around the target for both 2017 and 2018.

Our call on Peru’s monetary policy is unchanged: we expect the central bank to move entirely to a neutral stance soon, and maintain the reference rate at 4.25% throughout 2016 and 2017.


 

4. Calendar of monetary policy decisions in September


 


[1] We include Argentina and Paraguay.


 



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