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Latam Central Banks react to higher inflation

October 6, 2015

The depreciation of exchange rates have been pressuring inflation in Latin America, unsettling central banks in the region.

In September, 28 out of the 31 countries we cover made monetary policy decisions. Amid worries about global activity and a drop in commodity prices, four central banks (India, Taiwan, Norway and New Zealand) cut interest rates. In contrast, the depreciation of exchange rates have been pressuring inflation in Latin America, unsettling central banks in the region. Colombia and Peru unexpectedly hiked rates in September, while Chile’s central bank signaled that in the short-term a hike was likely. But the signal is for moderate increases, given the fragility of local economies.

In Brazil, inflation expectations have also been rising in response to the real’s depreciation. We believe that the central bank will opt to maintain the Selic rate stable, but will increase its actions in the currency market through several instruments.


 

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: Stable Selic Despite Everything

The Brazilian Central Bank’s Monetary Policy Committee (Copom) maintained the benchmark Selic rate at 14.25% in September. The decision was unanimous, and in line with expectations.

In its official communication,  (minutes of its meeting, Inflation Report) the Copom signaled its intention to maintain the monetary rate stable for an extended period, while acknowledging a worsening balance of risks produced by the exchange rate depreciation. According to the Copom “the scenario of inflation convergence to 4.5% by the end of 2016 has been maintained, despite some deterioration in the balance of risks, recently exacerbated by the effects of the downgrade in the sovereign credit rating.”

The Copom’s strategy to cope with FX pressures seems to be a scaling up of interventions that include the spot market, as opposed to rate hikes. This is, in our view, the signal given by BCB Governor Alexandre Tombini following the publication of the IR. However, we do not rule out a BCB decision to resume a moderate hiking cycle if inflation expectations deteriorate significantly (particularly for longer maturities).

Thus, despite the worsening balance of risks, the BCB's signaling and deepening recession led us to maintain our scenario for a stable Selic rate of 14.25% until the end of 2016.

MEXICO: Still on hold, waiting for the Fed

Mexico’s central bank left the policy rate unchanged at 3.0% at its September meeting, matching both our expectations and those of the market consensus according to Bloomberg. However, up until the Fed’s rate decision the previous week, most analysts expected a rate hike in September. In the statement announcing its decision, the board noted that the balance of risks for both activity and inflation had not changed since its previous meeting. In its concluding remarks, the board again highlighted the economy’s weak cyclical conditions, as well as the low inflation rate and well-anchored inflation expectations, in spite of the peso’s recent depreciation. Still, the future actions of the U.S. Fed remain a key concern.

With the currency still under pressure, the Exchange-Rate Commission (made up of members of the central bank and the finance ministry) announced the extension of the two intervention mechanisms currently in place. The central bank will continue selling USD 200 million daily without a minimum price and another USD 200 million every day when the exchange rate weakens by at least 1%.The mechanisms were extended to November 30 (they had previously been set expire on September 30).

We still believe that rate hikes in Mexico will come only in 1Q16, after a hike by the Fed in December and once it becomes clearer that Mexico is benefiting from the U.S. recovery. The downward surprises for both growth and inflation are consistent with our view on the policy rate.

CHILE: Rate hike in October

As widely expected, the central bank of Chile kept its policy rate unchanged at 3% in the September meeting, one month short from being an entire year on hold. However, the press release introduced a tightening bias, signaling that rate hikes are approaching. Specifically, the board indicated that the “sizable” monetary stimulus in place will likely be reduced in the “short term.” By qualifying the stimulus as “sizable,” the board indicated that it could hike rates amid weak growth figures: after all, monetary policy could remain expansionary even after some hikes.

The minutes from the monetary policy meeting show that the decision to hold the policy rate at 3.0% was split, for the first time since June 2014. While all board members saw the appeal of the rate-hike option, only one of them voted to raise the policy rate by 25 basis points, to ensure that inflation expectations are anchored and to prevent the need for a sharper and more costly (to activity and employment) hiking cycle later. Two other members believed that a rate hike could convey the wrong idea regarding the intensity and speed of the tightening cycle, compared to the cycle described in the 3Q15 Inflation Report (IPoM). The IPoM indicated that there would be a reduction of the monetary stimulus (with the policy rate rising 50 to 75 basis points) starting by the end of this year or the beginning of 2016. A fourth board member was not convinced that either option outweighed the other, in spite of which, he believed that the central bank’s communication had to adopt a clear bias for rate hikes in the short term.

We expect two 25-bp rate hikes in 4Q15 (one in October and another in November) taking the policy rate to 3.50% by year-end. Considering that activity continues to disappoint we see no further rate hikes in 2016. The modest tightening cycle will be aimed at keeping inflation expectations in check.

COLOMBIA: Rate hikes target inflation expectations

The central bank of Colombia increased its reference rate by 25 bps in September, to 4.75%, surprising most market analysts, which were expecting rates to be left on hold. At the previous two meetings the board was split over the question of whether to stay on hold, but the September hike had the backing of the entire board. This unanimity was also a surprise, given that recent communications from several board members indicated that some of them were still comfortable with the 4.5% policy rate level.

With both headline and core inflation on the rise, the central bank highlighted that the one- and two-year-horizon inflation expectations from surveys are in the upper half of the 2%-4% target range, while the expectations derived from certain asset prices (for two, three and five years out) are above 4%. The board thus acknowledged that expectations are “possibly unanchored”. In this context, the board argued that the risk of higher inflation and inflation expectations had increased since the previous meeting, while the risk of lower-than-expected economic growth remained broadly unchanged.

After the rate decision, comments made by a number of board members suggested that the rate hike was not necessarily the beginning of a sequence of rate increases (or at least a sequence of consecutive rate increases). These board members are selling the September decision as a signal to economic agents regarding the central bank’s commitment to bringing inflation down to the target. In fact, Finance Minister Cardenas (who is also a board member) explicitly said that the rate increase does not indicate the start of a tightening cycle. Meanwhile, co-director Adolfo Meisel said that the hike had an immediate impact on inflation expectations. Ana Maiguashca (another board member) said in an interview that the 25-bp rate increase was a signal aimed at anchoring inflation expectations and would not necessarily lead to an increase in household borrowing costs.

We expect only two additional rate hikes in this cycle, one before the end of this year and another in 1Q16. Evidently, the board is unwilling to hike much in an environment of weak economic growth. The evolution of inflation and (especially) inflation expectations will be key factors determining future policy moves.

PERU: A hike now, pause until the end of this year

Peru’s central bank surprised the market by raising the policy rate by 25 bps, to 3.50%, at its September meeting. The press release stated explicitly that this did not represent the start of a hiking cycle. The board indicated that they are attentively monitoring inflation and inflation expectations to evaluate the necessity of further rate adjustments, based on the goal of ensuring inflation’s convergence to the 1%-3% target range. Governor Velarde indicated more recently that, given the available data, there would likely be no reason to increase borrowing costs at the next two policy meetings (October and November).

The inflation report reaffirmed that the 25-bp hike was aimed at curbing the recent increase in inflation and inflation expectations. The central bank sees the new policy rate as consistent with the inflation path described above.

We do not expect the central bank to raise rates again this year (leaving the rate at 3.5% at year-end), but we do see rate hikes taking the policy rate to 4.0% in 1H16. 


 

4. Calendar of monetary policy decisions in October

* Source: Bloomberg


 



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