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Interest rate paths diverge in Latin America

May 5, 2017

In April, there were monetary policy decisions in 19 of the 33 countries we monitor.

In April, there were monetary policy decisions in 19 of the 33 countries we monitor. The number of central banks cutting interest rates exceeded the number of central banks hiking rates. Argentina's central bank hiked rates by 1.5 p.p. and Turkey’s central bank increased the late liquidity overnight rate by 0.50 p.p., both surprising the market. On the expansionary side, Brazil’s central bank cut rates by 1.0 p.p., as expected, and there were surprises in Chile (0.25 p.p. cut, while rates were expected to be held stable), Colombia and Russia (both with a 0.50 p.p. cut, more aggressive than the 0.25 p.p. expected cut in both countries).

In May, we highlight the monetary policy meetings in Brazil, Peru and Mexico. We expect the Brazilian central bank to deliver another 1.0 p.p. interest rate cut, bringing the Selic rate to 10.25%, whereas we expect a 0.25 p.p. rate cut in Peru and a 0,25 p.p. hike in Mexico.


 

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  A one-off hike?

The central bank kept the monetary rate (7-day repo) unchanged, at 26.25%, in its latest biweekly monetary policy meeting, after hiking the rate by 150 bps in early April. In the latest statement, the central bank indicated it was ready to act should inflation not resume a downward trend in May. Inflation picked up in the February-March period (2.5% mom on average), mostly due to adjustments in regulated prices. However, the central bank’s decision emanated from the fact that core inflation didn´t fall between 4Q16 and 1Q17 as well as unfavorable high-frequency data for April. In fact, core inflation averaged 1.7% mom in both quarters, a level inconsistent with the inflation range target set for the year (12%-17%).

The central bank announced a reserve accumulation target (through sterilized dollar purchases) that will be met mostly through hard-currency related to public sector debt issuance. While we note that last year the central bank was already accumulating a relevant part of the dollars generated by debt issuance abroad, the monetary authority has also purchased dollars in the exchange rate market recently. The central bank plans to increase gross international reserves to 15% of GDP, from its current level of 10%, in a period of one or two years (approximately USD 25.0 billion). While higher reserves are positive for the sovereign rating, dollar purchases will likely turn disinflation more challenging. 

Looking ahead, we still expect the policy rate to end this year below the current level, as we expect inflation to moderate. However, we note that new rate increases in the short-term are possible.BRAZIL – Stronger interest cuts ahead

There was no monetary policy decision in Brazil in March. The highlight was the 1Q Inflation Report (IR) published by the Brazilian central bank’s Monetary Policy Committee (Copom). The IR revealed inflation forecasts that make room for stronger interest rate cuts ahead. In the report, the Copom indicated that the ongoing scenario and more widespread disinflation increase the chance of a “moderate” intensification in the pace of monetary easing.

BRAZIL - Asymmetric risk for further acceleration of the easing pace in May

In April, the Copom unanimously cut the Selic rate by 1.0 p.p. to 11.25%, as widely expected. Although the Copom considers that the current pace (1.0 p.p.) is adequate, the committee assesses that the current economic environment recommends monitoring the evolution of the determinants of the degree of frontloading.

In the April meeting’s minutes, the Copom reiterated that the extension of the cycle would continue. The Copom pointed out that the pace of monetary easing will depend on the extension of the intended cycle and the degree of its front-loading, which in turn will depend on the behavior of economic activity, other risk factors and inflation forecasts and expectations.

The minutes also signaled asymmetry on future monetary policy movements. An important section reveals that the committee considered a more aggressive move than the 1.0 p.p. cut delivered, but ended up opting for "moderate" acceleration, given the forward looking nature of policymaking and the uncertainty around the scenario.

We expect the Copom to deliver another 1.0 p.p. cut at its next policy meeting on May 30 and 31. However, renewed frustration with activity data and, to a lesser extent but also relevant, a faster decline in inflation expectations and the advance of economic reforms in Congress might lead the Copom to accelerate the easing pace some more.

CHILE – Appetite for - limited – additional easing ahead

The board of the central bank of Chile unanimously decided to cut its policy rate by 25-bps to 2.75% at its April monetary policy meeting. The central bank initiated an easing cycle in January, strategically pausing in February, and resuming the cycle in March. The press release communicating the decision retained an easing bias stating the board will evaluate the need for "some" additional monetary stimulus.

All board members viewed domestic activity in line with the scenario outlined in the most recent Inflation Report, but acknowledged a sharper-than-expected deterioration of the labor market. The board noted that if falling waged employment and wages endured, they could have a negative effect on consumption ahead. These comments reaffirm our view that the evolvement of the labor market was the likely trigger of the rate cut last month, and would play a similar role going forward. Meanwhile, the evolution of inflation was not a source of concern.

Overall, we view that the central bank has a clear, but certainly limited, appetite for additional easing. We expect the policy rate to reach 2.50% before the end of the current quarter and remain there until the end of the year. However, we acknowledge that if activity, particularly through the labor market, disappoints further, additional easing might be on the cards.

COLOMBIA – Growth concerns lead to a more aggressive rate cut

The central bank of Colombia cut the policy rate by 50 bps, to 6.50%, at its April meeting. The decision was once again by split vote, with four co-directors falling in the majority, while the remaining two co-directors opting for a 25-bp cut. This was the sixth non-unanimous consecutive decision, with the move surprising two-thirds of Bloomberg’s respondents, as well as us, who expected a 25bp rate cut. The disappointing activity and increased risk of an excessive slowdown supported the move, while core inflationary pressure - previously raised as an area of unease - persists. The balancing act between these factors means the speed of monetary easing will remain data-dependent.

Flagging activity convinced most in the board of a more aggressive action at this meeting. The press release announcing the decision highlights the disappointing activity in 1Q17 (industrial production, retail sales and consumer confidence), leading the technical staff to lower its 2017 growth forecast to 1.8%, from 2% previously (2% in 2016). Meanwhile, inflation is evolving in line with expectations, led by the dilution of previous supply-side shocks. In fact, the central bank’s medium-term inflation forecast has declined amid the recent disinflation.

We expect the central bank to continue lowering the policy rate, but the pace of rate cuts will be data dependent. We see the policy rate ending the year at 5.5% (7.50% in 2016).

MEXICO – More hikes in the offing

With the recent exchange rate appreciation, the central bank found room to reduce the pace of rate hikes. The quarterly Inflation Report marked a turning point in the Central Bank’s guidance by stating that tightening aggressively could be “inefficient and costly for economic activity”. In the week after, Banxico’s board unanimously decided to smooth the pace of monetary tightening by hiking 25-bps (to 6.50%), departing from the last six policy moves (50-bps). Moreover, in April, Governor Cartsens told the press that Banxico “might not necessarily follow the Fed in the medium-term”.  

However, the latest inflation numbers, combined with benign activity data and the expectation of new hikes by the Fed, mean that additional rate increases are likely. Headline inflation is yet to peak and the behavior of diffusion indexes (69% of items in the CPI basket showing inflation higher or equal than 4%) and service inflation suggests second-round effects are materializing. In this context, the central bank still sees the balance of risks for inflation as tilted to the upside. Moreover, the central bank continues to highlight the interest rate differential with the U.S. as a key variable to monitor.

We still expect Banxico to take the reference rate to 7.0% in 2017, although we now believe that the next rate hike will come in May (rather than June). To be sure, it will be hard for Banxico’s board not to hike given the last high inflation prints, and to less extent the resilience of activity in 1Q17. Afterwards, the next hike will probably come in June, following the Fed.

PERU – A close call

The Central Bank of Peru (BCRP) decided to keep the reference rate at 4.25% in April – in line with our call and the market consensus – but has provided unequivocal guidance that it plans to cut rates. Following a 1p.p. cut of local currency reserves requirements (to 5%), and a sharp downward revision to its GDP growth forecast for 2017 (to 3.5%, from 4.3% previously) presented in the 1Q17 Inflation Report, the central bank introduced an easing bias. This doesn’t come as a surprise because in late March – when it became clear that the “coastal El Niño” would have a large impact on inflation and activity– Governor Velarde told the press that rate cuts are likely.

The latest statement featured major changes. The policy bias sentence now reads: “the Board is watchful of inflation and its determinants, especially the reversion of supply shocks, to loosen monetary policy in the short-term”. However, the new phrasing mentions that inflation expectations are close to the upper bound of the tolerance interval (around the 2-percent target), rather than “on a downward trend” as it stated before, indicating that easing may not come so soon.

We expect the first rate cut to come in May. In April, consumer prices fell, with annual inflation decreasing to 3.7% (from 4% in March). Meanwhile inflation expectations for the medium-term have stabilized. We expect the BCRP to deliver two rate cuts in 2017, taking the policy rate to 3.75% (from 4.25% currently), with a bias to do more rather than less.


 

4. Calendar of monetary policy decisions in May


 


 



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