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PERU - Monetary policy decision: on-hold, but more cuts in the pipeline

Agosto 11, 2017

Statement dropped out the “reversion of supply shocks” as a criterion to cut rates

The Central Bank of Peru (BCRP) decided to pause the easing cycle, amid an increase of inflation and an incipient improvement of activity, leaving the reference rate unchanged at 3.75%.  The decision was in line with our forecast and an almost unanimous market consensus (only one out of thirteen economists surveyed by Bloomberg expected a rate cut). The guidance in the previous monetary policy statement had conditioned future rate cuts to the evolution of inflation expectations, the reversion of supply shocks (mainly the effects of El Niño on food prices) and activity. Inflation expectations continued decreasing, as per the latest survey of expectations. However, annual inflation increased to 2.9% in July (from 2.7% in June), pressured by food prices, and the GDP proxy picked-up to 3.4% year-over-year in May (largely explained by the volatile natural-resource sectors) followed by a significant – yet incipient – improvement of coincident indicators for non-natural resource sectors in June. Therefore, only one out of the three criteria for rate cuts – spelled out in the statement – was met in August’s meeting, which is why it is no surprise that the BCRP’s board decided to pause this month.

The statement features two relevant changes; namely, more benign views on inflation, and the re-introduction of the exact same policy bias sentence that was featured in June’s monetary policy statement (which was modified in July). Regarding the inflation outlook, the board now sees both headline and core inflation (ex-food and energy) converging to the 2% target by the end of 2017, whereas previously the statement only said that headline inflation would remain within the 1p.p. tolerance range around the target in 2017 and 2018. Notably, the Board’s updated inflation outlook is also more optimistic than the official staff forecasts (shown in June’s quarterly Inflation Report) whose mid-point for 2017 is 2.3%. Turning to the policy bias sentence, we highlight that back in July’s meeting the Board signaled that it was not willing to embark upon an aggressive easing cycle, by changing the wording from “[…] continue loosening monetary policy in the short-term” (June’s statement) to “consider, if necessary, additional modifications in the monetary policy stance” (July’s statement). Nevertheless, the monetary policy statement published in August’s meeting featured the re-introduction of the exact same sentence that appeared in June:  “the Board is watchful of inflation and its determinants, specially inflation expectations and economic activity, to continue loosening monetary policy in the short-term”. So it is also worth pointing out that the triggers for future rate cuts will now be the decrease of inflation expectations and the weakening of activity (dropping out the “reversion of supply shocks”, which was mentioned explicitly as a third trigger in July’s statement).      

We continue expecting the BCRP to deliver no more than two additional 25-bps rate cuts in 2017. We note the Peruvian government has just announced a 20% hike in water service tariffs (only applicable to 67% of the population), and food prices (mainly fish, lemon, and food outside home) likely increased in August. So, removing the “reversion of supply shocks” as a condition for cutting interest rates signals the Central Bank is still willing to increase monetary stimulus. However, significant additional easing is unlikely. In fact, earlier this week Chairman Velarde stated that he foresees a scenario of “lower or stable rates”, still consistent with his previous guidance of only one or two (25-bp) rate cuts this year.    


 

Alexander Müller 


 

 



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