Itaú BBA - Global trend remains expansionist

Global Monetary Policy Monitor

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Global trend remains expansionist

June 3, 2016

In May, monetary policy decisions were made in 19 of the 31 countries we monitor.

In May, monetary policy decisions were made in 19 of the 31 countries we monitor.  Three countries cut interest rates: Australia, by 0.25 pp (it had been expected to keep rates steady), Hungary, by 0.15 pp, and Turkey, by 0.50 pp (both in line with expectations). However, Columbia continues to swim against the global current and raised rates again, by 0.25 pp, as expected.  

Publication of the minutes from the Fed’s most recent monetary policy meeting was also a significant event in May. The committee indicated that “most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.” 

In Latin America, the recent trend in exchange rates has reduced pressure on domestic prices, and monetary tightening cycles are coming to an end.  We expect most central banks to hold interest rates stable for the rest of year, with a rate reduction in Brazil.  Even in Colombia, recent monetary policy communications suggest few or no rate increases ahead. On the other hand, exchange-rate performance alongside a likely U.S. rate hike could push its central bank to raise the base rate again.

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 - Rate cuts only in the second half

There was no monetary policy decision in Brazil in May. The highlight was the minutes from Copom’s April meeting. The document emphasized that the balance of risks is still uncertain, as fiscal policy remains expansionary and inflation remains high. Copom forecasts indicate that, at this moment, inflation converges to the target only with the exchange and interest rates at current levels. Hence, the minutes reinforce signals that there is no room for interest rate cuts in the short term. However, new fiscal adjustment efforts and the downward trend in inflation, if confirmed, should create room for rate cuts in the second half of the year.

Balance of risks is still uncertain. Although recognizing recent progress in the fight against inflation, the Copom again noted “uncertainties associated with the balance of risks” (Par. 32). Among the factors worrying the committee are i) the fiscal scenario; ii) relative prices adjustments, which keeps year-over-year inflation and inflation expectations at elevated levels; iii) lingering external uncertainties.

Expansionary fiscal stance. Addressing the fiscal scenario, the Copom stated that “the public sector’s balance is in an expansionary zone,” rather than repeating that it “tends to move to a zone of restraint” (Par. 25). This is a sign that the committee sees the need for additional measures and reforms in order for fiscal policy to contribute to the disinflation process. 

Disinflationary economic activity. The Copom’s base-case scenario incorporates “moderation in credit”, continuity of the “process of increasing slack in the labor market” and an “output gap that is more disinflationary than initially expected” (Par. 26, Par. 31). 

Inflation converges to the target in the reference scenario, but not in the market’s scenario. Inflation forecasts in the reference scenario (constant exchange and interest rates at current levels) have receded since the release of the minutes of the previous Copom meeting, and are now “around the target” for 2017. The main reason behind the decline was probably the exchange rate, which strengthened to 3.55 reais per U.S. dollar (from 3.95 in the previous minutes). However, in the market’s scenario, which assumes falling interest rates and currency depreciation ahead, the inflation forecast for 2017 increased and remains above the 4.5% target.

No room for interest rate cuts in the short term. Facing this scenario, the Copom reinforced signals in the statement released after last week’s meeting, noting that current conditions “do not allow monetary policy easing” (Par. 32). This is a clear sign that the Copom will maintain the benchmark Selic rate at 14.25% p.a. in its next meeting, in June.

New fiscal adjustment efforts and lower year-over-year inflation going forward. Chances of another effort in terms of fiscal adjustments and reforms are increasing. Year-over-year inflation tends to drop further, as the effects of the adjustment in relative prices in 2015 stay behind. In this context, inflation expectations will probably continue to gradually recede.

Lower interest rates later on. If confirmed, this improvement in the balance of risks should make the Copom more comfortable to start a easing cycle in the second semester.

CHILE – About to drop the tightening bias?

As unanimously expected, the central bank left its policy rate unchanged at 3.50% at its monthly monetary policy meeting. The minutes of the meeting show the board was unanimous in its decision to stay on hold for the fifth consecutive month, following the start of a discontinuous tightening cycle in 4Q15.

Departing from previous meetings, the technical staff only proposed leaving the rate unchanged as a valid option. The option of hiking the rate by 0.25 pp was seen to have lost its appeal in line with low growth amid inflation that decelerated as expected, inflation expectations that remained anchored, and no notable deviation of the real exchange rate from its fundamentals.

The meeting hosted a discussion within the board regarding removing the tightening bias from its communication. While the board ultimately chose to adopt the same bias included in the previous meeting, the 2Q16 Inflation Report (IPoM) was viewed by most as the appropriate setting to reconsider any possible change to communication.

We expect the central bank to undergo a prolonged pause, holding the policy rate at 3.5% throughout this year and 2017. In our view, with declining inflation, low growth and well-anchored inflation expectations, it is unlikely that the central bank will resume the tightening cycle. The minutes of the latest meeting suggest the board is already moving towards a looser policy stance.

COLOMBIA - Another 25bp rate hike and no more call auctions

The central bank opted to increase the policy rate by 0.25 pp, as was expected by us and most analysts surveyed by Bloomberg. This is the ninth consecutive rate hike in a tightening cycle that has totaled 275 basis points.

At the press conference following the meeting, Governor Uribe announced that the decision was not unanimous, which has been the case since October last year. Previously, the board was split in terms of the magnitude of the rate hike. This time, it is unclear whether the minority voted for a 0.50 pp increase or to leave the policy rate unchanged. After the decision, some board members noted the tightening cycle is over or nearing its end.

The call option intervention mechanism was eliminated. After the intervention mechanism was activated for the first time, the central bank announced that it would no longer utilize the auction of up to USD 500 million call options if the exchange-rate exceeds the 20-day moving average by more than 3% on any given day. The use of the mechanism was to limit the volatility of the exchange rate rather than target a specific level. However, the central bank noted that it will utilize discretionary intervention measures (without detailing the mechanisms) if the circumstances warrant it. Mauricio Cardenas – the Finance Minister - said that the government will continue to sell dollars.

We expect the central bank to implement one final 0.25 pp hike in this tightening cycle, taking the policy to 7.5%. The timing of this hike will depend on the evolution of incoming data (inflation and inflation expectations).

PERU - Another month on-hold

The central bank of Peru held its policy rate at 4.25%, as expected by us and nearly 90% of those surveyed by Bloomberg. This was the third consecutive month on hold in a tightening cycle, initiated last September, that has so far consisted of 1 pp. Lower inflation and inflation expectations, and the strengthening of currency over the past two months are, in our view, the key reasons for the decision to maintain the policy rate at the current level. Still, the press release retained a tightening bias. 

We expect the central bank to hold the policy rate at 4.25% throughout the remainder of this year and 2017. As inflation remains in a declining path, further rate increases are unlikely. However, because inflation is still above the target range, the economy recovering, and a tightening bias is still present, rate hikes cannot be ruled out if inflation surprises to the upside again.

MEXICO – Probability of rate hikes are rising

Mexico’s central bank left the policy rate unchanged at 3.75% in May, as widely expected. Like in the previous meeting, the minutes showed that two board members (likely the usually more hawkish ones) were more vocal regarding the need for additional rate hikes. Again one of them explicitly said that the policy rate differential between Mexico and the U.S. should not narrow, while both agreed that the central bank of Mexico may need to hike independently of the Fed given the uncertainty over the global scenario. The majority of the members did not give a clear signal for rates going forward, but the board, as a whole, continues to pledge that it will monitor for the upcoming decisions (probably in this order of importance): the evolution of the exchange-rate, the interest rate differential with the U.S. and the evolution of the output gap.

When presenting the inflation report, Governor Carstens commentaries didn’t indicate an imminent response to the recent weakening of the Mexican peso. Still, doors are open for a response (including interest rate hikes in an extraordinary meeting) if necessary. Specifically, he mentioned that the Mexican peso is weakening due to external factors and that exchange-rate trading has been orderly, adding that the evolution of the currency now is different from the one in February (when the central bank raised the policy rate and moved to discretionary intervention). However, Governor Carstens also said that the central bank would act to ensure the exchange-rate trades on fundamentals, while also saying that “our hope is to make decisions in scheduled meetings”.

The recent behavior of the Mexican peso - if sustained - amid a growing probability of another hike by the Fed in the near term could lead the central bank to raise interest rates again (by 0.50 pp) in the next meeting. At first, we see another rate increase in an extraordinary meeting (like in February) as unlikely, but we can’t rule out the board recurs to intervention to limit further exchange-rate weakening until the board meets to decide rates on June 30.

4. Calendar of monetary policy decisions in June


** Decision already made.



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