Itaú BBA - Mexico and South America in opposite trends

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Mexico and South America in opposite trends

April 5, 2017

In March, there were monetary policy decisions in 26 of the 33 countries we monitor.

In March, there were monetary policy decisions in 26 of the 33 countries we monitor. For another month, the number of central banks hiking interest rates was equal to the number of central banks cutting rates. On the contractionary side, the US and Mexican central banks hiked rates by 25 bps, while in China several interest rates were up. On the expansionary side, Chile and Colombia reduced rates by 25 bps, in line with expectations, and the Russian central bank surprised the market with a 25-bp rate cut (when it was expected to stay on hold).

We expect the monetary easing process to continue in South America. We forecast additional cuts in Brazil, Chile, Colombia and Argentina. In Peru, we now also expect rate cuts. In Mexico, the pace of monetary tightening is slowing, consistent with the more favorable behavior of the exchange rate and real interest rates already at a contractionary level. We expect two additional rate hikes (25 bps) in Mexico this year, before the cycle ends.

In April, we highlight the Brazil’s monetary policy meeting. We expect the BCB to accelerate the pace of interest rate cuts to 100 bps, bringing the Selic rate to 11.25%. In developed economies, monetary policy decisions will be made in Japan and the Euro Zone, but we do not expect changes in current stimulus policies.


 

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 – Is a hike coming?

The central bank continues to keep the policy rate (7-day repo) at a high level (24.75%). However, the inflation outlook remains uncomfortable. Not only the headline inflation accelerated to 2.5% mom in February (from 1.3% in January) propelled by the adjustment of regulated prices but also the core reading registered an increase to 1.8% mom, from 1.3% in the previous month. Furthermore, the central bank said in the statement of its most recent policy decision that there were mixed signals from the high-frequency inflation indicators for April. In this context, it said it was ready to act, hinting that an increase in the policy rate is on the table.

In fact, the central bank has been recently mopping up liquidity in the market through sales of short-term peso bills (Lebac’s). As a result, the yield of these instruments rose 200 bps, to 24%. 

Following the most recent decision, inflation expectation for 2017 has increased to 21.2%, from 20.8% according to the central bank’s March survey. So, expectation distanced further from the inflation target for 2017 (12%-17% range). Annual core inflation expectations also increased, to 18.7% from 18.5%in February.

While we do not expect rate increases in our baseline scenario, the probability of rate increases is clearly on the rise.

 

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.

In its projections, the committee presented forecast horizons up to 1Q19. In addition to the usual baseline scenario (constant exchange rate and interest rate) and market scenario (market exchange rate and interest rate), the Copom once again published estimates under two alternate scenarios, one with constant exchange rates and interest rates according to market expectations, and the other with constant interest rates and exchange rates according to market expectations.

Inflation estimates for 2017 are below the target in all four scenarios presented by the Copom. Forecasts for 2018, which are increasingly gaining importance in Copom discussions, are on target or slightly below it in the scenarios that consider market expectations for interest rates (specifically, 9.0% at the end of 2017 and 8.5% at the end of 2018). This is a key message conveyed by the report: the easing cycle that drives the interest rate to 9.0% at the end of this year and to 8.5% at the end of 2018 is not inconsistent with reaching the inflation target.

In summary, the IR fits the current market pricing, with authorities signaling a "moderate" increase in the pace of easing, which we take to mean an increase to 100 bps from 75 bps. We thus expect the Copom to cut the Selic by 200 bps in April and May, in two equal installments (100 bps per month).The main message in this report is conveyed by the 2018 inflation forecast under the “market scenario,” which projects inflation at 4.5% for 2018, the current inflation target – this signals that the easing cycle that drives the interest rate to 9.0% at the end of this year and to 8.5% at the end of 2018 is not inconsistent with reaching the inflation target. For the time being, we stand by our call that the Selic rate will end the year at 8.25%, but the forecasts presented in this report tilt the balance of risks for this call to the upside.

 

CHILE – More easing ahead

The board of the central bank of Chile unanimously decided to cut the policy rate by 25-bp to 3.0%, as expected by the market and us. The central bank initiated the easing cycle with a quarter-point cut in January, thereafter strategically pausing in February.

Importantly, the press release announcing the decision retained an easing bias. The central bank noted that recent macroeconomic trends (low inflation and weak activity) could require additional monetary stimulus. The Inflation Report (IPoM) published after the meeting confirmed that baseline scenario for the trajectory of the policy rate includes one additional 25-bp cut in the near term.

We believe that more than just the one additional rate cut will materialize. Growth continues to disappoint, external imbalances are limited and inflation will likely remain below the 3% target for the remainder of the year. We expect the next rate cut to come in 2Q17, with the final cut to 2.5% to come in 2H17, concluding a 100-bp easing cycle.

 

COLOMBIA – A consecutive rate cut

In March, the central bank of Colombia cut the policy rate by 25-bp to 7.0%, in line with Bloomberg’s market consensus. We, however, felt that the evolvement of macroeconomic indicators (activity, inflation, and inflation expectations) over the month would lead most board members to opt for an acceleration of the easing cycle –with a 50-bp cut. The decision was reached through a three-way split with one co-director preferring to stay on hold, Finance Minister Mauricio Cardenas opting for a 50-bp cut, while the remaining four co-directors fell in the majority. This was the fifth consecutive split vote.

The content of the statement is in line with more easing in the near term. The explicit reference to the rate cut being consistent with meeting the 3% target in 2018 shows the board is focusing on a longer forecast horizon than previously. Until recently, the central bank was emphasizing the goal of bringing inflation to below 4% this year. In terms of activity, the board acknowledged the recent indicators pose downside risk to the 2% growth forecast for this year. Furthermore, the board continues to see the current level of real interest rate is historically high.

We expect rate cuts to continue. There is clear concern over the evolution of activity, while inflationary pressures are diminishing and external imbalances correct. We see the policy rate ending the year at 5.5%. For now, it appears likely the central bank will continue easing through 25-bp moves.

 

MEXICO – Smoothing the pace of monetary tightening

Banxico hiked the policy rate by 25-bps in March (to 6.5%, from 6.25%), following the Fed. The last six policy rate moves, between February 2016 and February 2017, were 50-bp hikes. So this marks a departure in the pace of tightening. In fact, in the recent Inflation Report stated that hiking aggressively in the short-term could “inefficient and costly for economic activity”. In the concluding remarks of the statement announcing the decision, the central bank explicitly mentioned the 25-bp rate increase of the Fed as one of the reasons for the decision to hike. Looking ahead, the central bank remains focused on the same factors as before: second-round effects from the shocks affecting domestic prices, the relative monetary policy stance between Mexico and the U.S., and the output gap. Still, the board clearly took some comfort with the behavior of the currency and said that there was no additional deterioration of the balance of risks for inflation. At the same time, board members are a bit more optimistic with the economy as tail risks (U.S. trade policies) are diminishing, arguing that there was some improvement of the balance of risks for activity.

We read the recent rate hike and guidance as consistent with our scenario (only a couple more 25-bp rate hikes, after each move of the Fed). We see the reference rate at 7% by the end of the year, so Banxico would decouple from the Fed at some point. The better exchange-rate behavior, the already high level of real interest rates (above the central bank’s own estimations of neutral rate in the short to the medium-terms) and the expectation of economic deceleration plays in favor of less aggressive tightening. For 2018, provided that inflation decreases and GDP growth remains sluggish, we believe rate cuts are likely.

 

PERU – Switching into an easing bias

The Inflation Report presented in late March, as well as recent comments from Governor Velarde, indicate that the Central Bank is changing its policy bias from neutral to accommodative. During the presentation of the Inflation Report, the BCRP announced the reduction of local currency reserve requirements to 5% (from 6%). The BCRP had been reducing foreign currency reserve requirements since December, as the rise of U.S. treasury yields had tightened credit conditions in Peru’s partially dollarized economy. More importantly, Chairman Velarde told the press that the board may consider a rate cut in the coming meetings.

The bias shift comes amid lower growth forecasts. The BCRP revised down the GDP growth forecast for 2017, to 3.5% (4.3%), arguing that the massive flooding (“coastal El Niño”) and the interruption of large infrastructure projects (caused by a corruption scandal involving construction firms)  will have significantly negative effect in the economy. The GDP growth forecast for 2018 was trimmed 0.1p.p. (to 4.1%, from 4.2%). On the inflation front, forecasts are significantly more optimistic than market estimates. The BCRP expects inflation to end 2017 at 2.4% (up from 2.3% in the previous inflation report), whereas the forecast for 2018 remains at 2%. Nevertheless, the staff of the central bank stressed the risk that the flooding could make inflation shoot up in the short-term, with potentially adverse effects on inflation expectations.

Against this backdrop, we expect the BCRP to deliver two 25-bp rate cuts before the end of the year (to 3.75%, from 4.25%). However, the BCRP will likely stop short of cutting rates in the next few meetings, at least until it has confidence that inflation expectations are not being contaminated (something that cannot be ruled out if more flooding and landslides happen, knocking out food prices to higher levels). We expect rates to be maintained at 3.75% in 2018.


 

4. Calendar of monetary policy decisions in April


 


 



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