21-Sep –Latam central banks are tightening up

All five main central banks in Latin America are sounding hawkish, despite the magnitude and duration of the external headwinds faced by their economies. In a world of free-floating exchange rates (or nearly free) the currency is the initial absorber of external shocks. However, it is only a matter of time before the shock propagates to inflation and inflation expectations. The end result is an uncomfortable blend of softer growth, higher inflation and a weaker currency. Having held off from addressing such ‘transitory’ inflation pressures, we see Latam central banks - except Brazil, which started tightening last year - ready to start raising policy rates.

We think Colombia’s Banco Central de la República (BanRep) is likely to deliver a 25bps hike at its 25 September meeting, raising the overnight rate to 4.75%. July and August decisions were split, and concerns over inflation pass-through are mounting. Despite weaker activity, domestic demand remains relatively resilient. An interest rate hike would lift real interest rates, preventing inflation expectations from de-anchoring, while also boosting the currency. We look for an additional 25bps hike by BanRep in October, followed by a pause. BanRep could resume hiking in Q1-2016.

Chile’s Banco Central de Chile (BCCh) is also sounding more hawkish and we expect a hike before year-end. The statement from BCCh’s September MPC meeting highlighted that “the sizable monetary stimulus in place will likely be reduced in the short term”. We now expect BCCh to deliver a 25bps hike at its December meeting, raising overnight rate to 3.25%. The hiking cycle should continue into 2016, plateauing at 4.00% by the end of Q1-2016.

Peru’s Banco Central de la República de Perú (BCRP) has already started normalising rates. In September, it surprised markets by raising the overnight rate 25bps to 3.50%. We expect an additional 25bps hike in Q4, which should help BCRP manage FX market expectations, aside from being a remedy to an increasingly concerning inflation outlook. Both headline and core inflation was above 4.0% in August. With the prospects of a severe El Ni?o into 2016, further spikes in food inflation seem likely, which should keep BCRP on the hawkish side.

Brazil’s Banco Central do Brazil (BCB) has explicitly called for rates to stay on hold for a prolonged period in order for inflation to converge to the centre of the target range by the end of 2016. However, the monetary policy committee (COPOM) remains vigilant, and we do not rule out entirely the possibility of BCB resuming its hiking cycle, should the rise in USD-BRL become disorderly.