Itaú BBA - Interest rate differential with the U.S. to narrow further in South America

Global Monetary Policy Monitor

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Interest rate differential with the U.S. to narrow further in South America

March 3, 2017

We expect the monetary easing process to continue in South America and the Fed to hike interest rates in March.

In February, monetary policy decisions were made in 18 of the 33 countries we monitor. The number of central banks hiking interest rates has equaled the number of central banks cutting rates. On the expansionary side, Brazil's central bank reduced rates by another 75 bps, in line with expectations, and in Colombia, the central bank surprised the market with a 25 bps rate cut (while it was expected to stay on hold). On the contractionary side, in Mexico, Banxico implemented another 50 bps rate hike, and in China, several interest rates were up.

We expect the monetary easing process to continue in South America. We forecast additional rate cuts in Brazil, Chile, Colombia and Argentina. On the other hand, in Peru, our forecast is for interest rates to remain unchanged, while in Mexico, we expect rate hikes along with the Fed.

In March, we highlight the decisions in developed countries. We expect the Fed to hike interest rates on strong current data, well-behaved financial conditions and the outlook for a more expansionary fiscal policy ahead. In Europe, England and Japan, we expect that the respective central banks will likely maintain the current stimuli.


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 –Still on-hold

The Argentine central bank kept the reference rate (7-day repo rate) unchanged throughout February, at 24.75%.The policy rate has been on hold for three consecutive months now.The range of the 7-day repo rate is delimited by the central bank lending rate (active repo rate), at 25.75%, and the borrowing rate (passive rate), at 24.0%. New policy rate decisions will now be announced on a bi-weekly basis (instead of weekly).

The president of the central bank, Federico Sturzenegger, stated publically that there is no room to ease monetary policy due to the upcoming CPI readings.Expected hikes in regulated prices will impact (directly and indirectly) headline inflation in the February-April period. Sturzenegger also highlighted that non-regulated prices have been growing at 1.3% mom on average since November 2016 and the next policy rate decisions will seek to lower the pace of non-regulated price increases to a rate consistent with bringing headline inflation to the target.

With regard to the ongoing wage negotiations, Sturzenegger expressed confidence in the consolidation of a “forward-looking outcome”.In particular, he stated that wage hikes slightly above the inflation target range would not compromise the actual inflation target.

As inflation moderates and wage increases do not deviate meaningfully from the inflation target, we expect the central bank to resume interest rate cuts in 2Q17.The on-going recovery of activity leaves room for the central bank to be cautious before engaging in further monetary easing.


BRAZIL –Increased degrees of freedom

At its February monetary policy meeting, the central bank decided to make another 75-bp rate cut, bringing the Selic rate to 12.25%. In its minutes, the committee explained the state of the ongoing policy debate and stressed that coming decisions will depend not only on the assessment of aspects of its forecasting model, such as the “structural interest rate” but also on incoming data and the balance of risks.

Overall, the minutes suggest the authorities are quite open to the idea of accelerating the pace of easing, beyond the current 75bps, but have yet to make up their minds entirely.The text also hints that the committee may be debating whether intense front-loading of the cycle may not affect its duration.

We stick, for now, with the call that the next policy move in April will also be a 75bps rate cut, and that the Selic will end the year at 9.25% pa, but we concede that the risk is for faster rate cuts and a lower terminal rate this year. Regarding the prospective scenario for inflation and rates, we attach particular importance to the March edition of the Quarterly Inflation Report, which may clarify (and ideally quantify) the committee’s assessment on the new, presumably lower, structural interest rate in the Brazilian economy.


CHILE – Debating the size of the cycle

At its February monetary policy meeting, the central bank of Chile left its policy rate at 3.25%, as was expected by a narrow market majority, according to Bloomberg, and by us.The press release announcing the decision retained a loosening bias, signaling further easing would continue in the short term.

The minutes of the meeting reveal a unanimous decision to leave the policy rate unchanged, following the beginning of an easing cycle the previous month.At the meeting, the technical staff proposed cutting the policy rate by 25-bps or staying on hold as the relevant options to consider. This is a change from the January meeting, when only rate cuts of varying magnitudes were considered. The discussion in the minutes reflects a cautious approach from the central bank, while still acknowledging that at least the second rate cut envisioned in the 4Q16 Inflation report (IPoM) is necessary. Delivering the cut already in February had a communicational problem: leaving the easing bias could lead market participants to expect excessive easing ahead, whereas removing the bias (and consequently shutting the door to further easing in the short-run) could be too premature given the cyclical position of the economy.

We see the next rate cut in March with the retention of an easing bias. Overall, we still see a full cycle of 100-bps this year, taking the policy rate to 2.5%. In spite of strong inflation readings expected for 1Q17, the likelihood that inflation languishes near the base of the 2%-4% target range persists. The firming of the Chilean peso and a widening output gap supports further inflation deceleration and calls for additional monetary easing.


COLOMBIA – Timing of rate cut surprises

The central bank of Colombia surprised the market for the third consecutive month by cutting the policyrate by 25-bp to 7.25%. We, alongside the majority of analysts surveyed by Bloomberg, were expecting the central bank to stay on hold following the decision to keep rates on-hold the previous month. Considering that concern over rising inflation expectations was the justification for not lowering the policy rate in January, the further increase in the 2017 measure since that meeting makes the decision a curved ball. The decision was once more by majority, with a swing from the 4-3 vote in favor staying on hold in January, to a 4-2 split in favor of rate cuts. Gerardo Hernández, set to replace Carlos Gustavo Cano, was not able to participate in the meeting.

In the press conference, both Finance Minister Cardenas and Central Bank General Manager Echavarría mentioned the sharp fall of consumer confidence to a historical low as the key factor behind the rate cut.Also, the board warns in the press statement that if this is reflected to private consumption, growth in 2017 could be around 2%, representing no recovery from last year. In spite of the rising 2017 inflation expectations, Echavarría noted that the effects of the inflationary shocks are diminishing and said that there was now a 45%-55% chance that 2017 inflation hits the self-imposed 4% target (up from 40%-50% previously). While the most likely scenario has the policy rate falling in coming months, as mentioned explicitly by Echavarría, the debate will be over the speed of rate cuts.

While the February rate cut came as a surprise, it reinforces our view that the policy rate will end this year at 5.5%. The timing of rate cuts has become more unpredictable, as the board is divided and its composition isgoing through meaningful changes (in fact, the next meeting will likely have two new board members).


MEXICO – Focusing on inflation expectations

The Central Bank of Mexico (Banxico) published the first quarterly inflation report of 2017, with an updated outlook that reflects the staff’s views of weaker activity ahead and high inflation (this year). Previously, Banxico’s official GDP growth forecasts for 2017 and 2018 stood at 1.5%-2.5% and 2.2-3.2%, whereas now they have been cut to 1.3%-2.3% and 1.7%-2.7%, respectively. Regarding inflation, the staff expects headline inflation to stand above the target range throughout 2017 (in line with the latest guidance provided in monthly statements), and then decrease to “close to 3” in 2018. The latter forecast remains unchanged from the previous report. 

As indicated by the most recent communication of the central bank, there is more concern about inflation expectations. The central bank explicitly mentions the “further increase of inflation expectations” as one of the factors that could drive inflation higher. This contrasts with the previous inflation reports, where the discourse revolved around the notion that short-term inflation expectations have increased but long-term tenors remain well-anchored.

However, the Central Bank now highlights that hiking rates to fight short-term inflation shocks can be “inefficient and costly in terms of economic activity”. Furthermore, it also reminds that monetary policy acts on prices with lags. The monetary policy rate is already at a level (6.25%) above the upper bound of Banxico’s estimates of the neutral rate (4.3%-5.2%).  

We still expect Banxico to take the reference rate to 7.0% in 2017, with three 25-bp rate hikes following each move of the same magnitude by the Fed. In particular, we expect the Fed to raise interest rates already in its March meeting. Greater concerns on activity coupled with high inflation expectations mean that additional tightening is likely, but at a more moderate pace than before. The better behavior of the exchange-rate, if sustained, will also play in favor of slowing the pace of rate hikes.


PERU – Central Bank cut foreign currency reserve requirements

Peru’s Central Bank (BCRP) announced that foreign currency reserve requirements will be cut again in March 2017, arguing that this move will support credit growth in the context of higher international interest rates and slower domestic credit. The foreign currency marginal reserve requirement will be cut, from 48% to 46%, which will bring down the effective reserve requirement rate (35%). In contrast, the domestic currency reserve requirement – whose minimum rate is equal to the marginal rate (6%) – was modified in an unusual way (which should lower the effective rate in a small degree). Specifically, the reserve requirement of domestic currency liabilities indexed to the exchange rate (“special regime”) - the FX collateral tied to repo operations with the Central Bank (regular repo, expansion repo, and substation repo) - will also be lowered from 48% to 46%. Given that the combined amount of these repo contracts is PEN 25 billion, we estimate that the 2p.p. reserve requirement cut will free PEN 500 million in liquidity (around USD 1.5 million) for bank lending.

We do not believe that the lowering of reserves requirements marks the beginning of an easing cycle, and still expect the BCRP to maintain the policy rate at 4.25% throughout 2017. Granted, this move signals that the BCRP is somewhat more concerned about the weakness of domestic demand and the slowdown of credit, but a rate cut in the short-run is still unlikely. Inflation rose to 3.25% year-over-year in February (from 3.10% in January), and a climate shock risk (heavy rainfall in the northern coast that affects agriculture and disrupts transport) is still looming. Moreover, inflation expectations are hovering in the upper half of the Central Bank’s target range (their anchorage is not that robust, so rushing into an easing cycle could have undesirable consequences on inflation dynamics). Additionally, Governor Velarde recently stated that the rise of terms of trade is a strong reason to be optimistic with economic activity.


4. Calendar of monetary policy decisions in March


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