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Looser monetary policy stance in Latin America

July 4, 2017

The number of central banks reducing policy rates was equal once again to the number of central banks hiking rates.

In June, there were monetary policy decisions in 20 of the 33 countries we monitor. Policy rates were reduced in Russia (by 0.25pp, in line with expectations) and Colombia (by 0.50pp, in line with the consensus, but above our expectation of 0.25pp). On the other hand, in Mexico and the U.S., the monetary authorities hiked rates again by 0.25pp, in line with expectations.

Therefore, the number of central banks reducing policy rates was equal once again to the number of central banks hiking rates.

In July, we expect central banks in developed countries to continue to signal the gradual removal of stimulus, given lower global risks and falling unemployment. In Latin America, we expect further easing of monetary policy. We see cuts in Brazil (0.75pp), Colombia (0.25pp) and Peru (0.25pp). In Chile, we expect a stable policy rate, but there are risks of rate reductions before the end of the year, considering the weakness of activity and low inflation. In addition, the central banks in Argentina and Mexico, which have recently raised policy rates, indicated that further rate hikes are unlikely.


 

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 – Removing the tightening bias, but postponing interest rate cuts

The central bank kept the monetary policy rate unchanged at 26.25% for the fifth consecutive time at its second meeting in June. In the first meeting of June, the central bank had removed the tightening bias from the statement announcing the policy decisions, given that inflation data was consistent with disinflation. Still, in the most recent statement, the central bank warned that high frequency data for June indicate that inflation remains at a high level (although lower than in the quarter ended in April).

Consumer prices in July will likely remain under pressure due the rapid weakening of the peso in late June and the scheduled adjustments of fuel and health prices. The peso has weakened after the Argentine equities failed to be re-categorized to Emerging market in the MSCI index, but more markedly after former president Cristina Kirchner announced her decision to run for a senatorial seat in the Province of Buenos Aires. According to recent polls, Kirchner runs head-to-head with the incumbent´s candidate.

In this context, a rate cut in the next meeting (July 11, when the National CPI will also be published by Indec) is unlikely. We note the president of the central bank, Federico Sturzenegger, stated that overconfidence in the disinflation process led to excessive cuts in the reference rate in November 2016 (200-bps), suggesting a cautious approach for monetary policy going forward. In our view, the monetary authority will likely wait for further evidence of disinflation before starting a gradual easing cycle.

 

BRAZIL – Future steps depend on scenario developments

The National Monetary Council set a lower inflation target for 2019 and 2020 of 4.25% and 4% respectively. The decision has no significant implications for the monetary-policy stance, given that inflation expectations already incorporated a lower target. However, the new target helps anchoring long term inflation expectations and signals an eventual convergence for even lower inflation levels over time.

Forecasts in the Central Bank’s Inflation Report for 2Q17 are consistent with a continuing easing cycle, with the Selic rate moving toward 8.5%-8.0% by year-end, as indicated by the Focus survey. Inflation estimates for 2018 (the relevant horizon for monetary policy) are below the target in three out of four scenarios presented by the Monetary Policy Committee (Copom). Forecasts for 2019, which will become ever more important in committee discussions, range from 3.8% to 4.3% – thus below the current 4.5% target and consistent with the reduction of the 2019 target to 4.25% by the CMN. Importantly, these forecasts seem to contain above-consensus estimates for regulated prices and, thus, may retreat over time.

However, in our view, lower inflation (with a benign composition) and weaker activity will push the Central Bank toward a longer easing cycle. We expect the Selic at 8.00% by YE17, and reduced our forecast for YE18 to 7.5% from 8.0%.

According to the Inflation Report, the next Copom decision may be either a 75- or 100-bp cut in the Selic rate. In fact, the text refers to the signaling of deceleration, presented in the latest policy meeting statement and minutes, in the past tense, thus corroborating the possibility of sustaining the easing pace at 100 bps in the July 25-26 meeting.

Given the heightened uncertainty in the scenario, we stick to the view that the Copom will cut the Selic rate by 75 bps, to 9.5%, in July, instead of opting for a more aggressive reduction. However, further disappointment with the economic recovery and benign inflation surprises could convince the Copom to keep the faster easing pace, particularly if political uncertainties cool off and reforms go back to the table.

 

CHILE – On-hold

The central bank of Chile opted to keep the policy rate at 2.5% in June, as unanimously expected by market participants. The press release announcing the decision retains the same neutral bias adopted in the previous meeting and is in line with a board content to wait and observe how the economy unfolds given the monetary stimulus already implemented.

The central bank sees the economy evolving in line with its 2Q17 inflation report scenario. The press release announcing the decision noted that inflation expectations remain anchored and that available activity indicators for 2Q17 are in line with forecasts. In the minutes of the meeting, one board member noted that only significant deviations from the central bank’s baseline scenario (GDP growth of 1.0%-1.75% this year and 2.5%-3.5% next year) could translate into rate moves.

We do not expect the central bank to implement further rate cuts this year and only see the start of a normalization process towards the end of next year. We see an economic recovery through the remainder of the year and 2018, aided by higher average copper prices (vs. 2016), expansionary monetary policy and the benefits of low inflation. However, there remains a meaningful risk that activity doesn’t pick-up.

 

COLOMBIA – Easing cycle continues

In June, the central bank of Colombia cut its policy rate by 50-bps, to 5.75%, extending the easing cycle that started in December to 200-bps. The decision was the eighth consecutive split vote, with four co-directors falling in the majority, while the remaining three members preferred a 25-bps cut. The central bank board showed greater concern for activity, with Governor Echavarría noting at the press conference that the central bank sees an improvement in activity only in 2H17. This likely means the central bank sees downside risks to its 1.8% growth forecast for the year.

However, the statement announcing the decision reveals there remains some unease over the speed of inflation’s convergence to the 3% target. While headline inflation fell in May (to 4.4%), the underlying components continue to show some stickiness. Additionally, the central bank noted that the main drag on inflation - food prices - will likely show some reversion in 2H17, when inflation is anticipated to pick up from the minimum levels expected by mid-year. 

We expect the central bank to take the policy rate to 5.25% this year (through 25-bp cuts in each of the next two meetings). Recently, Governor Echavarría indicated the policy rate could reach this level in 2017, so 50-bps of further easing is likely on the cards. We cannot rule out additional easing as the board could act on disappointing activity. However, besides the unfavorable developments on inflation, the slower correction of external and fiscal imbalances could inspire some restraint within the board.

 

MEXICO – Transitioning into a neutral stance

The Central Bank of Mexico decided to hike the reference rate by 25bps (to 7%), in line with our call and market expectations, but - more importantly - it signaled that the monetary tightening cycle is likely over. The minutes of the previous meeting had already revealed that “some” board members believed that Banxico was getting close to the end of the tightening cycle. Nevertheless, June’s statement is much more assertive. In fact, the forward guidance paragraph features a new sentence, which clearly signals their intention to stop: “the Board considers that given today’s increase, and taking into account the transitory nature of the shocks, the fact that monetary policy acts on prices with lags, and the central bank’s own forecasts, the reference rate has reached a level that is consistent with the convergence of inflation to the 3% target”. Put simply, Banxico's baseline scenario is not to hike anymore. 

The decision was split, with one board member voting to leave the policy rate unchanged. Usually, split votes are revealed only in the minutes, so it seems to us the central bank wanted to pass a message on future decisions also by including in the statement the dissenting vote. Governor Carstens’ presentation of the Inflation Report and Deputy Governor Díaz de León’s recent remarks to the press make it clear that they were the two board members who were advocating the end of the tightening cycle in May’s minutes.

Granted, June’s statement also spells out that the Board is “vigilant to ensure a prudent monetary policy”, so the doors for hikes are not completely shut. However, in our view, the bar for more rate increases has been set significantly higher, meaning that only large upside surprises on inflation could lead the board to hike again.

Against this backdrop, we see the policy rate in Mexico stable throughout the rest of this year. But considering the contrasting views within the board (revealed in the minutes), with two other board members believing that the tightening cycle cannot end until inflation starts trending down, we expect split decisions ahead.

Rate cuts are likely in 2018, but Banxico will probably refrain from delivering them until 2H18. Although a substantial decrease of annual inflation is likely in 1Q18, potential volatility ahead of the presidential elections (to be held in July 2018) and U.S. Fed rate hikes will likely reduce the board’s appetite for rate cuts. Also, the fact that board members do not see the current real interest rate as tight, and the likelihood that the economy will be exhibiting decent growth rates in 2018 (as long as the U.S. economic recovery continues and uncertainty over trade relations with the U.S. fades) reduce the urgency to cut interest rates.

 

PERU – Rate cuts in the offing

The central bank left its policy rate unchanged in June, but maintained an easing bias. In addition, in its second quarterly inflation report of 2017, the central bank confirmed that it intends to continue cutting interest rates in the short run. In the report presentation to the press, Chairman Velarde emphasized the recent changes in the forward guidance paragraph featured in the board’s monthly policy decision statement. As stressed by Velarde, the statement explicitly mentions that the bias continues to be “loosening monetary policy in the short-term”, but the triggers for further loosening have changed. Specifically, the central bank’s focus has shifted from the “reversion of supply shocks” (the spike in food prices caused by El Niño) to “inflation expectations and the evolution of economic activity” as the key variables that will condition the next rate decisions.

Given the weakness in activity and the downward trend in inflation, we expect the BCRP to deliver three additional 25-bp rate cuts in 2017 (the next one this month), taking the reference rate to 3.25%. A cut in July seems likely because it would meet the two conditions for a rate cut spelled out in the board’s monthly statement. Inflation expectations will probably decrease in the next BCRP survey, considering the three negative inflation surprises in a row (May’s print came in as the biggest surprise in more than 10 years) and the fact that annual inflation has fallen by almost 130-bps in the past three months (to 2.7% year-over-year in June). As for the second condition, the GDP proxy grew by a poor 0.2% year over year in April, and coincident indicators point to a fragile recovery (we forecast a 2.7% year-over-year growth rate in May), as growth was likely largely explained by a one-off 280% year-over-year increase in fishing output. The non-natural resource sectors, however, likely remained weak in May (the three-month moving average growth rate was 0.3% year-over-year in April). Moreover, in a recent interview, board member Elmer Cuba provided a pessimistic view on the economy, arguing that he foresees annual GDP growth rates around 2.2% and 3.2% for 2017 and 2018, respectively (below the BCRP’s official forecasts, 2.8% and 4.2%).  


 


 

4. Calendar of monetary policy decisions in July


 



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