Latin American Central Banks Seen Raising Interest Rates Further

A report by Brazilian investment firm XP says central banks should continue to raise interest rates in the face of persistent commodity price pressures, bottlenecks and overheated demand

With less inflationary pressure, XP sees room for interest rate cuts next year, with Brazil's Selic rate closing 2023 at 10%.
September 19, 2022 | 06:26 PM
Reading time: 5 min.

Bloomberg Línea — The global effort by central banks to control skyrocketing inflation has led to an unprecedented increase in interest rates around the world, and which is likely to cause a sharp deceleration in economic activity. In Latin America, inflation continues on an upward trend, and with continuous surprises, and which has made a number of financial institutions revise upward their projections.

This is the case of XP, which sees a pressured inflation, and no signs of relief in the region.

In a report shared exclusively with Bloomberg Línea on Monday, XP highlighted that inflation in major Latin American economies continues on an upward trend, reflecting continued pressures from high commodity prices, bottlenecks in production chains, amid high aggregate demand.

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The assessment is that central banks in the region will have to raise interest rates even higher, as rising food and energy prices continue to have a strong impact on the cost of living, and which is spreading to other sectors of the economy.

“With persistently high inflation, central banks in the region have maintained an accelerated pace of interest rate increases, and will still need to continue on an upward trajectory,” according to the authors of the study, Francisco Nobre, economist at XP, and Andres Pardo, head of macroeconomic strategy for Latin America.

With the exception of Brazil, which has already entered a process of de-inflation, XP raised the inflation projections for the other major Latin American economies. The economists say, however, that they have not abandoned the expectation that the global de-inflation process will start in the remaining months of the year.

For Nobre and Pardo, the monetary tightening cycle is nearing its end, and the terminal interest rate will be reached by the end of 2022 in most countries in the region.

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“For 2023, we see room for cuts in the second half, but interest rates should remain at high levels relative to historical standards. Consequently, tighter financial conditions should contribute to an easing of aggregate demand, and reduce pressures on prices,” the economists write.

In addition, the XP team points out that the fall in commodity prices and the normalization in production chains contribute to global disinflation.

Here are XP’s projections and estimates for inflation and interest rates in Brazil, Colombia, Mexico and Chile:

Brazil: Projections improve despite global uncertainty, approaching elections

Three weeks before the presidential elections on October 2, XP highlights that the fiscal challenge in Brazil is big, as well as the demand for structural reforms.

With the perspective that the economy will continue to recover, the company raised once more the projection of GDP growth this year from 2.2% to 2.8%. For 2023, the forecast for growth has been raised from 0.5% to 1%.

Under the effect of tax reductions and benefited by the global decompression of costs, inflation has been falling in the country, and the CPI registered deflation in July and August. For this year, XP estimates a high of 6.1% for the consumer price index (compared to 6.8%), while for 2023, the projection is now 5.3% (compared to 5.5%).

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According to Nobre and Pardo, with inflation expectations stabilizing, Brazil’s central bank should interrupt the monetary tightening cycle.

“Without fiscal disruption, we see room for interest rate cuts next year, with the Selic rate ending 2023 at 10%,” they write.

“However, it is still too early to celebrate. The sustainability of these encouraging results depends on the fiscal policy of the next government, the prospects for reforms, and the post-pandemic global rebalancing. In any case, there are signs that the Brazilian economy has the potential for a favorable cycle ahead. It remains to be seen whether we will seize the opportunity,” write the analysts.

Mexico: Continued inflationary pressures, higher interest rates

In August, inflation in Mexico came in higher than expected, suggesting continued pressures. The CPI advanced 0.70% during the month, with monthly variations running above the range of the last 10 years, and accumulated inflation over the past 12 months advanced from 8.15% in July to 8.70% in August, marking the highest increase since April 2021.

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In the report, XP highlights that inflation in Mexico is at historically high levels, but below the peak of inflation found in other countries in the region. With continued pressures, the team revised its inflation projections for the end of 2022 from 8.2% to 8.5%. For the end of 2023, the estimate is for inflation of 5.3% in the country.

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“We believe that Banxico [Mexico’s central bank] will maintain the accelerated pace of monetary tightening. With inflation running above central bank expectations, we believe a third consecutive 0.75-percentage-point increase at the next meeting is most likely [they had previously projected 0.50pp], which would take interest rates to 9.25%,” the XP analysts say.

XP also revised up expectations for the terminal interest rate, from 9.75% to 10.0%, which should be reached by the end of the year, according to Nobre and Pardo.

Chile: Discounted assets reflecting domestic and international risks

Inflation in Chile is among the highest in Latin America. The CPI advanced by 1.2% in August, above market expectations, and marked the sixth hike above 1% during the first eight months of the year.

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XP evaluates that the de-inflation process in Chile will gain traction in the following months, but at a slower pace. The analysts revised up their inflation projections for the end of 2022 from 11.5% to 12.3%. With the de-inflation process accelerating next year, the projection is that inflation will end 2023 at 5.6%.

In the economists’ evaluation, Chilean assets should continue to be volatile, reflecting a high risk premium.

“We assess that the rejection of the new constitution should have a positive impact on Chile’s financial assets in the short term, reflecting an easing of fiscal risks. However, political uncertainties should remain elevated, as staying with the current constitution is not considered an option, and the constitutional debate will continue,” Nobre and Pardo write.

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Colombia: Overheated economy puts pressure on inflation

For Colombia, XP raised its projections for year-end inflation from 10.2% to 11.2%. For 2023, its estimates have risen from 5.8% to 6.1%. The assessment is that Colombia’s central bank is expected to maintain an accelerated pace of hikes, but that it is approaching the end of the cycle.

“With inflation persistently pressured, the focus should be on cooling economic activity, which remains very heated, as soon as possible,” the economists say. XP maintains expectations that the central bank will end the cycle of interest rate hikes in October, and projects a terminal rate between 10.75% and 11.0% (versus 10% previously).

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