Analysis: Latin central banks look beyond COVID as ghosts of inflation loom


MEXICO CITY / NEW YORK (Reuters) – Latin America’s central banks have become more hawkish as the region’s inflationary ghosts shake their chains, with a recent U.S. Federal Reserve pivot further raising market expectations for policies more stringent monetary policies.

FILE PHOTO: A general view of the Central Bank of Brazil during the coronavirus disease (COVID-19) outbreak in downtown Brasilia, Brazil, March 20, 2020. REUTERS / Adriano Machado / File Photo

Over the past three weeks, the central banks of Brazil and Mexico, the region’s two largest economies, have raised benchmark interest rates, widely telegraphed in the first case but shocking markets in the second.

These measures showed how a red alert on inflation suddenly sounded for policymakers in a region where countries like Brazil have spent years battling hyperinflation and others like Argentina are still battling it. double-digit annual price increases.

They overshadow the moves by the Fed, which last month began shutting the door on its ultra-easy pandemic-focused policy. U.S. central bankers have predicted an accelerated timeline for interest rate hikes and have opened discussions on how to end bond buying in times of crisis.

Inflationary pressure in Latin America stands in stark contrast to emerging economies in Asia, where central banks are largely on hold, with weak demand as economies struggle to recover from the pandemic.

The road back to the pre-pandemic era

In Brazil, markets now expect year-end interest rates to be above their late 2019 levels, before COVID-19 lockdowns and when inflationary pressures were harder to detect.

Mexico is expected to hike rates by more than 1.25 percentage points, or 125 basis points (bps), by the end of the year, after its first hike since 2018. Colombia, which has raised rates for the last time in 2016, is expected to increase by more than 150bp by year-end, despite expectations defying expectations with an accommodating statement after the last central bank meeting.

“Some central banks may have to hike rates beyond what they were before the COVID shock, as the COVID shock came with much higher commodity prices and weaker currencies, a rare combination “said Gustavo Medeiros, deputy director based in London. research at Ashmore, a fund manager focused on emerging markets.

He said the trend for weakening currencies had changed, “which means those inflationary pressures in the future are going to be much lower.”

Case in point: The Brazilian real fell almost 8% in the first quarter, among the weakest major currencies at the start of the year, but rebounded to be the best performer in the last quarter with an increase of more than 13% .

This sudden turnaround is due in part to Brazil’s central bank, now one of the most hawkish in the emerging world. At the turn of the year, its Selic benchmark rate was at an all-time high of 2% and central bank Copom’s rate setting committee had a forward guidance policy to indicate that rates would stay there.

With inflation higher than expected, Copom made its first rate hike in nearly six years in March. He didn’t look back, increasing by 75 basis points in each of his next two meetings to 4.25% and even discussing a larger increase at his June meeting.

“As the global economy recovers rapidly, inflationary pressures have appeared first in emerging markets,” rating firm S&P said this week, highlighting the acceleration in the tightening of monetary policy in Brazil. “Other Latin American countries are expected to do the same by the end of the year.”

Economy Minister Paulo Guedes said last week that the real had room to strengthen “much more”. The Copom could have some leeway over interest rates if a stronger currency can ease inflationary pressures, analysts say.

Investors demand more yield to hold Latam debt


In Chile, a strong recovery in demand, firmer terms of trade, rising inflation and a “very low” nominal policy rate “are supporting the start of a gradual process of monetary policy normalization”, he said. said Goldman Sachs chief economic officer in Latin America, Alberto Ramos.

Chilean policymakers discussed the rate hike in June, raising the likelihood of a first move this month. Markets expect the main rate, now 0.5%, to be around 2% by the end of the year, above 1.75% before COVID.

Mexico raised its key rate by 25 basis points to 4.25% last week, reinforcing expectations of further hikes. The market, so far, has forecast 110 basis points for further hikes by the end of the year.

Year-on-year inflation in Mexico was 6% in mid-June, double the central bank’s 3% target.

In Colombia, where inflationary pressures have remained benign amid a crushing spike in COVID-linked unemployment even as the peso has weakened by more than 9% this year, the central bank is seen to have a smoother slope to climb.

“Colombia’s inflation outlook is more comfortable and has been very comfortable until recently. That’s why they have more time to react, ”said Mauro Roca, managing director of sovereign emerging markets research at investment management firm TCW. “Even then, we should see a more hawkish tone in preparation for takeoff later in the year.”

Managing expectations will be the key factor in maintaining the credibility of the region’s central banks, whether through more hawkish statements or real hikes.

“Much of the macroeconomic health of countries in the region will depend on the credibility that their central banks can bring to the market,” economist Jonathan Fortun of the Institute of International Finance told Reuters.

“Failure to do so has left very painful consequences in the region at various times in the past. “

Reporting by Abraham Gonzales in Mexico City, Rodrigo Campos in New York and Jamie McGeever in Brasilia; Editing by Christian Plumb and William Mallard

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