Mixed inflation pictures are leading to diverging monetary policy responses in the region.
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The global cycle is changing
Global growth is improving and we believe global inflation will start to gradually normalize, as the output gap in developed economies turns positive and deflationary pressure from China eases.
Easing cycles closer to an end
Activity in the region is gradually recovering, but mixed inflation pictures are leading to diverging monetary policy responses. Still, we note that easing cycles, where ongoing, are coming closer to an end.
Getting closer to the end of the cycle
In a context of gradual economic recovery and less benign inflation at the margin, the central bank signaled another interest rate cut in December, but left the February decision wide open.
Renewed optimism faces no shortage of challenges
The administration emerged stronger from the mid-term elections, which will allow the ruling coalition, led by president Macri’s Cambiemos, to seek tactical alliances to pass key fiscal reforms.
Domestic and external uncertainties return
The latest round of NAFTA renegotiation raised the odds of a break-up. In addition, PAN party has split, benefiting the ruling PRI and anti-establishment candidate Andrés Manuel Lopez-Obrador.
Easing-cycle discussion still alive
Expansionary monetary policy, improving private sector sentiment and higher global growth will all aid an activity recovery. Limited inflationary pressures mean that further rate cuts cannot be ruled out.
More than just green shoots
Peru’s activity is showing more than just green shoots, with indicators pointing towards a strong pick-up in coming quarters. Inflation is falling faster and we believe the central bank will seize the opportunity to deliver the final (25-bp) rate cut of its easing cycle in November.
Rate cut comes ahead of schedule
In a split decision, the central bank surprisingly cut the policy rate by 25 bps in October, to 5.0%, on the back of a more favorable inflation outlook. We still expect the easing cycle to end with a policy rate of 4.5%.
Higher copper prices, lower agricultural prices
Commodity prices rose in October, boosted by 4.4% increase in its energy subcomponent. We increased our yearend copper and nickel forecasts. On the other hand, we lowered our forecasts for agricultural prices.
Easing cycles closer to an end in Latam, in a context of improving global growth
Global growth is improving but still has room to become more widespread. We raised our GDP growth estimates for the U.S., Europe and China, increasing our global projection to 3.8% for 2017 and 2018, from 3.6% and 3.7% respectively. We believe global inflation will start to gradually normalize as the output gap in developed economies turns positive and deflationary pressure from China eases. The main risk is an accelerated correction in DM interest rates due to a rapid approval of tax cuts or inflation pressures in the U.S, thanks to the eventual revival of Philips Curve dynamics, but these risks do not seem worrisome at the moment.
With higher U.S. treasury yields, most LatAm currencies weakened in October. The Mexican peso underperformed, reflecting noise over presidential elections next year and NAFTA renegotiations, while rising copper prices supported the Chilean peso and the Peruvian sol. Activity in the region is gradually recovering, but mixed inflation pictures are leading to diverging monetary policy responses. In October, two central banks surprised expectations: in Colombia, the policy rate fell by 25 bps following a downside surprise in inflation, and in Argentina there was a 150 bps hike in response to inflation stickiness. Still, even in countries that are reducing interest rates, easing cycles are coming closer to an end.
In Brazil, the Monetary Policy Committee cut the Selic rate by 75 bps in October, as widely expected, and signaled a 50-bp cut in December, but left the February decision wide open. Our year-end forecasts for the Selic rate were maintained at 7.0% for 2017 and 6.5% for 2018. We increased our 2017 inflation forecast to 3.3% due to greater pressure from regulated prices, but our estimate for 2018 inflation remains at 3.8%. We anticipate GDP growth of 0.8% in 2017 and 3.0% in 2018, but we do see risks: domestic factors have a negative bias, while the stronger global environment works in the opposite direction. Our forecast for unemployment at year-end 2018 was revised downward, to 11.8% from 12.0%. Exchange rate forecasts were unchanged, at BRL 3.25 per USD in 2017 and 3.50 in 2018.