Itaú BBA - Latin America still in easing mode

Global Monetary Policy Monitor

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Latin America still in easing mode

August 4, 2017

In Latin America, there is still room for interest rate cuts in most countries under our coverage.

In July, there were monetary policy decisions in 23 of the 33 countries we monitor, with rate cuts in 3 emerging economies and a rate hike in one developed economy.

Specifically, policy rates were reduced in Brazil (by 100-bps), Colombia (by 25-bps), Peru (by 25-bps) and South Africa (by 25-bps). On the other hand, in Canada, the monetary authority implemented a 25-bp hike, in line with expectations. Only in South Africa, the move surprised market expectations.

As a result, the number of central banks cutting interest rates was once again higher than the number of central banks hiking policy rates.

In Latin America, there is still room for interest rate cuts in most countries under our coverage. In Brazil, the policy rate stands at 9.25% and we forecast 7.25% by the end of this year. The central banks in Colombia and Peru are indicating that the easing cycle is approaching the end, and we expect, respectively, a 25-bp cut and two additional cuts of the same magnitude this year. In Chile, the central bank has adopted a neutral tone, but low inflation and weak growth are likely to persuade the board to increase the monetary stimulus (we expect two additional 25-bp cuts this year). In Mexico, the tightening cycle has probably ended, but board members are emphasizing that rate cuts are unlikely in the near future, given the uncertainties surrounding the NAFTA negotiations and the 2018 electoral process. Finally, in Argentina, the disinflation process has become more challenging, with core inflation still running at high levels and a more depreciated exchange rate pressuring upcoming inflation data. In this context, we expect that Argentina's central bank will be more gradual when the monetary easing process starts (we expect the policy rate at 25% by the end of the year, compared to 22% in our previous scenario and 26.25% currently).


 

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

Reducing inflation in Argentina has proven to be challenging, as core readings have remained high (around 22% annualized over the past three months). The recent depreciation of the peso, a direct consequence of political uncertainties, will make reducing inflation even harder. In this context, Argentina’s central bank has left the monetary policy rate unchanged at 26.25% since the beginning of April (when it implemented a 150-bp hike). At the same time, the monetary authority has tightened monetary policy through the yield paid on its short-term sterilization bills (LEBAC), bringing it to the center of the range delimited by the passive and active repo rates (25.5%-27%). While the central bank has emphasized that the current real ex-ante policy rate is tight, the monetary authority sees no room for easing. We now expect a more gradual easing cycle, with the policy rate ending the year at 25% (up from 22% in our previous scenario). The outcome of the midterm elections is a key risk for interest rates. A positive outcome for the government in the elections could strengthen the currency and lead to more rate cuts than we are now expecting, but a victory by Cristina Kirchner (especially if it’s by a wide margin) could force the central bank to raise interest rates, especially considering that the low level of reserves does not allow for aggressive and systematic exchange-rate intervention.

In Brazil, the central bank matched expectations in July with a 100-bp cut, taking the Selic rate to 9.25%. This marks the return of the Selic rate to single-digit territory for the first time since November 2013. The minutes of the meeting suggest that the debate within the monetary policy committee on the cut to be announced at the upcoming meeting remains limited to an interval between 75-bps and 100-bps. But the base scenario is an additional 100-bp cut in September, as, unless a shock occurs, the macroeconomic scenario will hardly change much until then. After that, taking into account the stage of the cycle, the committee is likely to moderate the easing pace to 50-bp per meeting, taking the Selic rate to 7.25% by the end of the year.

In Chile, the economy remains sluggish, and inflation came in significantly below expectations in June. The central bank of Chile left the policy rate unchanged in July, maintaining a neutral bias in its statement. However, the minutes revealed that one board member had voted for a 25-bp rate cut. Although the majority of board members opted to leave the policy rate unchanged and to keep the neutral bias, the minutes also showed that two members within the majority were open to the idea of further easing. Specifically, one member believed that the June CPI reading amounted to a material downside risk to the inflation outlook, while another member saw downside risks to inflation, which could prompt further easing. In this context, we expect two additional 25-bp rate cuts this year, bringing the policy rate to 2.0% by year-end. In our view, the next cut is likely to come after the publication of the 3Q17 monetary policy report (scheduled for early September).

Colombia’s central bank continued the current easing cycle at its July policy meeting, but slowed the pace to 25 bps (from 50 bps previously), bringing the policy rate to 5.5%. The board was less split than it had been earlier in the year, with only one member dissenting and voting to leave the policy rate unchanged. In the lead-up to the meeting, several board members (including two who had previously voted for more aggressive monetary policy action) indicated that the space for rate cuts had narrowed. In the press conference announcing the decision, Governor Echavarría went further, arguing that this space has narrowed even more. In our view, the communication is consistent with our call for only one additional 25-bp rate cut in August, followed by a pause in the cycle. Looking further ahead, we foresee more rate cuts next year (bringing the policy rate to 4.5%), given our expectation of a sluggish economy and lower inflation and the fact that most board members do not see the current policy rate levels as expansionary. However, the weakening fundamentals of the Colombian economy (particularly the still-wide twin deficits) and the prospect of Fed rate hikes in 2018 pose a risk to our forecast of further easing.

In its latest decision, Mexico’s central bank increased its policy rate by 25 bps and indicated that the recent tightening cycle is likely over. The minutes from the meeting confirmed the message conveyed in the statement, that additional rate hikes are not completely off the table (given the risks to inflation converging to the target) but the bar for further tightening will be high. Importantly, however, many board members have also recently suggested that rate cuts will not come soon either. For instance, the board member who voted to keep the policy rate steady noted in the minutes that it could be difficult to implement rate cuts in 2018, given the uncertainties associated with the presidential election (to be held in mid-2018). Governor Carstens also saw the elections and prospective NAFTA negotiations as obstacles to rate cuts before the second half of next year. Other board members who fall in the more hawkish camp have also called for a conservative policy approach. These comments are consistent with our view that rate cuts will not come in the near future. Besides the political (domestic and external) uncertainties, we believe that rate hikes by the Fed, a solid U.S. economy (which is limiting the deceleration of the Mexican economy) and the fact that board members do not see current policy rates as tight will also play against rate cuts. We project a year-end policy rate of 7.0%. In 2018, we expect two 25-bp rate cuts in the second half.

In Peru, the central bank delivered the second cut of its current easing cycle in July (25 bps), bringing the policy rate to 3.75%. Given the weakness of non-natural-resource sectors (the part of the economy most sensitive to cyclical factors), further easing is likely. However, the central bank is signaling that it will not cut rates much further. Governor Julio Velarde said recently that he foresaw only one or two additional 25-bp rate cuts. The guidance is in line with our call for two more 25-bp rate cuts this year. The board is concerned about the fact that long-term inflation expectations seem to be stuck in the upper half of the tolerance range around the two percent target. Also, BCRP policymakers have made it clear that they believe the shocks affecting the economy will dissipate in 2018, and that fiscal policy – not monetary policy – should lead the efforts to pump up macroeconomic stimulus.


 

4. Calendar of monetary policy decisions in August


 



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