Itaú BBA - Lower interest rates in South America

Global Monetary Policy Monitor

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Lower interest rates in South America

February 2, 2017

We expect the easing process to continue in South America.

In January, monetary policy decisions took place in 15 of the 33 countries that we monitor. On the tightening side, Turkey increased the upper-bound of the range for interest rates. In South America, interest rates are on a downward trend, although central banks in Colombia, Argentina and Peru chose to maintain their benchmark rates unchanged during the month. In Brazil, the central bank accelerated the pace of cuts in the Selic rate to 75 bps, in line with our call. In Chile, the central bank reduced rates by 25 bps.

We expect the easing process to continue in South America. In Brazil, we anticipate 75-bp cuts in the February and April meetings. Given that the inflation scenario is more benign than expected, we believe that the Selic rate will end 2017 at 9.75%. In Chile, the easing cycle will probably add up to 100 bps. In Argentina, we see additional rate cuts, even though the inflation target is unlikely to be achieved (12% to 17%). On the other hand, Peru should maintain its interest rate unchanged. In Mexico, we expect the central bank to hike rates by 50 bps in February and then proceed to match increases by the U.S. Federal Reserve (i.e. three additional hikes of 25 bps before year-end).

In February, there are important policy decisions in developed economies. The Fed maintained its benchmark rate and signaled that further increases will be data-dependent, contributing to sustain a favorable external environment for emerging economies. The Bank of England did not extend its asset-purchase program.


1. Policy rates: Historical table


2. Charts


3. Monetary policy in LatAm

ARGENTINA – Central Bank remains On-Hold, amid higher inflation expectations

The Argentine central bank has kept the reference rate (7-day repo rate) on hold at 24.75% along January. The central bank adopted a new monetary policy framework in 2017, setting the center of the 7-day repo-rate range as the monetary policy instrument and abandoning the 35-day Lebac rate that prevailed in 2016. There is a range for the 7-day repo rate that is delimited by the central bank lending rate (active repo rate), at 25.75%, and the borrowing rate (passive rate), at 24.0%. In practical terms, the range sets a floor and a ceiling for the 1-day inter-banking lending rate. The central bank said in its latest monetary report that it chose the 7-day rate to avoid unnecessary interventions in the functioning of the one-day market. The spread of the range was set considering the advantages of reduced interest rate volatility and the cost of higher intervention in the market. Beginning in March, the central bank will announce its monetary decision on a bi-weekly basis, not weekly as it has been doing since the implementation of the inflation targeting scheme in September 2016.

The monetary policy stance remains tight.In the January monetary report, the central bank explained that the nominal rate is based on the expected inflationary trend according to central bank’s surveys, its own estimates and breakevens. The nominal rate has been cut by 1,325 bps since March 2016, to the current level of 24.75%. The reduction in nominal rates accompanied the disinflation process in 2H16 but kept the ex ante real interest rate relatively stable, according to the central bank’s estimates (between 6% and 9%, annualized). According to the latest survey on market expectations compiled by the central bank, participants expect a real interest rate of around 5% in the next months. In our view, the central bank has kept unchanged the reference rate mostly because inflation expectations increased recently, distancing further from the 12%-17% target range set by the central bank. We forecast inflation of 22% and a repo rate of 20% by December 2017.

BRAZIL –Lower interest rates in 2017

At its January monetary policy meeting, the central bank decided to make another interest rate cut, this time of 75 bps, bringing the Selic rate to 13.00%, in line with our expectations. 

In its statement and the meeting minutes, the committee signaled the possibility of at least one more 75-bp cut in February, but did not commit to delivering it. This strategy is justified, in our view, because inflation is falling faster – and more broadly – than expected and activity is failing to meet expectations in an environment where inflation expectations are anchored. The central bank also indicated that this movement is consistent with a front-loading of the monetary easing cycle but not, in principle, with a change in the total budget for monetary loosening. In our view, rising unemployment will continue to help bring down inflation, and given no further uncertainty abroad, this should allow the central bank to maintain a faster pace of monetary policy easing over the next several meetings.

We expect two additional 75-bp cuts at the February and April meetings. We have lowered our year-end Selic rate forecast for 2017 to 9.75% (previously 10%), as the inflationary scenario is more benign than we anticipated. Looking at 2018, we believe that the continued downward trend in inflation and high levels of unemployment are consistent with further interest rate cuts. We expect a Selic rate of 8.50% at the end of 2018.

CHILE – Expected start of the easing cycle

As widely predicted, the central bank of Chile started the year with a 25 basis points rate cut after being on hold for a full year. The decision to lower the policy rate to 3.25% followed a sustained period of weak activity and faster than expected disinflation. The press release announcing the decision retained the same loosening bias introduced in the previous month and quantified in the 4Q16 Inflation Report (IPoM), supporting the expectation of more easing ahead.

Inflation surprised to the downside at the close of 2016. While short-term inflation expectations are near the lower bound of the 2%-4% target range, the press release highlighted that inflation forecasts for the relevant horizon remain anchored. Meanwhile, the board outlined limited demand side pressures. 

We expect the central bank to cut the policy rate again this quarter, to 3.0%, and thereafter implement further easing later in the year as inflation wallows around 2%. We see the policy rate ending 2017 at 2.5%, implying a 100-bp cycle (beyond the 50 bps envisioned in the 4Q16 IPoM).

COLOMBIA – A discontinuous easing cycle

The central bank of Colombia surprised the market by leaving its policy rate unchanged in the first monetary policy meeting of the year. Following the earlier than expected rate cut in December, the market was near unanimous in its expectation for a 25 basis point rate cut. However, the central bank opted to leave the policy rate at 7.5%. The decision was once more by majority, with a swing from the 4-3 vote favoring a rate cut last month, to a 4-3 split favoring rates on hold. Juan José Echavarría led the meeting for the first time.

According to Echavarría, the board agrees that there is a need for monetary easing, but there is divergence on the timing and speed of rate cuts.The board acknowledges that the real interest rate is above the historical average since 2005 and that activity remains weak. However, the majority of the board appears concerned by inflation expectations. The central bank has been targeting 2017 inflation within the 2%-4% target range, but the latest survey of analysts puts the expectation for this year at 4.5%. Governor Echavarría noted that he wants to reach the inflation target “as soon as possible”, with a 40% to 50% chance of hitting the 4% self-imposed target by yearend.

A negative output gap and the fading impact of supply side shocks on inflation support the call for further easing ahead.Yet, as each rate cut will likely be data dependent, there exists a growing risk that fewer rate cuts than we currently expect materialize. Hence, the policy rate could end the year above our current 5.5% forecast. Having said that, the upcoming replacement of two of the seven board members could change the board’s inclination for further monetary easing ahead.

PERU – Rates on-hold

The Central Bank of Peru (BCRP) decided to maintain the reference rate at 4.25% in January’s meeting, amid higher inflation forecasts.The 4Q16 inflation report, published previously, had already shown an increase in the inflation forecasts for 2016 and 2017. Inflation ended 2016 at 3.2%, above the Central Bank’s target range for a third consecutive year. On the activity front, GDP growth slowed down significantly in 4Q16 (expanding at an average pace of 2.9% year-over-year in October and November, well below the 4.4% print of 3Q16). Domestic demand has weakened. 

The statement had two relevant changes; namely, a less benign inflation outlook and an acknowledgement of weaker growth.First, it mentions that inflation will likely converge back to the target range by mid-2017 (rather than decrease to 2% by the end of 2017, as it read previously). In other words, this means the board believes inflation will stay above 3% (upper bound of the target range) for six more months. Second, the statement now acknowledges that GDP growth has slowed down.

We still expect the BCRP to maintain the policy rate at 4.25% throughout 2017 and 2018.Inflation decreased to 3.1% in January, but is still hovering above the target range (1%-3%). Moreover, there are upward risks to inflation in the short-run, as adverse weather conditions (drought followed by abrupt flooding) threaten to disrupt agricultural supply. So the BCRP will likely remain watchful. Looking beyond that, we expect to economy to grow 3.8% and 4.0% in 2017 and 2018, respectively, close to potential growth (around 4.0%), and inflation to converge to target range before the end of 2017. Against this backdrop, it is likely that monetary policy will stay neutral (4.25% is in the realm of what is considered the neutral rate). 

4. Calendar of monetary policy decisions in February

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