Joao Pedro Resende, Andrés Pérez M., Vittorio Peretti & Carolina Monzón
31/01/2023
The central bank’s quarterly monetary policy report revised inflation up due to strong indexation and food supply disruptions, justifying an extension to the tightening cycle. The central bank’s technical staff estimates a still positive output gap and higher path of inflation to be compatible with a policy rate trajectory that, on average, is somewhat above the central bank’s analyst survey expectations (that sees the rate peaking at 13% and ending the year at 10%, while reaching 6.0% by the end of 2024). Additionally, the technical staff maintained the estimated real neutral rate at 2.2% for this year and revised up to 2.3% in 2024 (both at 2.2% previously). The 1-year ex-ante real policy rate now stands at 5.0%, sitting significantly in contractionary territory.
A deeper economic slowdown is expected given the higher inflation and rates scenario. The Central Bank's staff revised its 2022 GDP growth forecast up by 0.1pp to 8.0% (Itaú: 8.2%; +10.7% in 2021), but cut the 2023 GDP growth forecast by 0.3pp to 0.2% (Itaú: 0.6%). Potential GDP was revised up to 4.3% from 4.2% for 2022 and to 2.8% from 2.6% for 2023. The updated scenario points to a positive output gap in 2022 of 2.5% (2.3% in the previous estimation), while returning to -0.1% by the end of 2023 (+0.2% in November’s report).
Increasing risk of de-anchoring inflation expectations. The 2023 yearend inflation estimate was revised up by 1.6pp to 8.71% (Itaú: 8.7%; 13.1% last year), due to resilient domestic demand, amid a tightening labor market, ongoing supply constraints, and COP weakness. However, the technical staff expects that inflation will decelerate in 1Q23 in response to the contractionary monetary policy. Core inflation is expected to reach 8.7% this year (+192bps from November’s outlook; 9.5% in 2022) boosted by indexation. For 2024, the technical staff expects inflation to return to the target range, reaching 3.5% by the yearend (Itaú 3.6%; analyst survey expectation: 5%).
A gradual current account deficit correction ahead. The staff now sees a CAD at 6.3% of GDP in 2022 (+0.3pp from the previous report, 5.7% in 2021) amid upbeat domestic demand. The economic slowdown in 2023 will aid a CAD correction to 3.9% this year. In our view, large twin deficits amid tightened global financial conditions will keep the COP vulnerable to shocks.
We believe the tightening cycle is close to concluding, with incoming data determining the terminal rate. We expect a 50bp increase to 13.25% at the next monetary policy meeting (March 31). Significant inflation persistence would prevent early rate cuts. We see rates ending this year at 10.5%. The meeting minutes to be released on Tuesday and the Monetary Policy Report presentation on Wednesday should provide further insights on the policy rate path going forward.
Carolina Monzón
Vittorio Peretti