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On March 20, 2020, a general view of Brazil’s Central Bank in downtown Brasilia, Brazil, during the coronavirus illness (COVID-19) outbreak. REUTERS/File Photo/Adriano Machado NEW YORK/MEXICO CITY, July 2 (Reuters) – As the region’s inflationary ghosts rattle their chains, Latin America’s central banks have become more hawkish, with the US Federal Reserve’s recent tilt bolstering market expectations of tighter monetary policies. The central banks of Brazil and Mexico, the region’s two largest economies, upped their benchmark interest rates in the last three weeks, which were generally anticipated in the first case but surprised markets in the second. The steps highlighted how an inflation red flag has suddenly sounded for policymakers in a region where some nations, such as Brazil, have struggled with hyperinflation for years and others, such as Argentina, are still dealing with double-digit annual price increases. They coincide with Fed measures, which began closing the door on its pandemic-driven ultra-easy policy last month. Central bankers in the United States forecasted a faster pace of interest rate hikes and began discussions on how to cease bond-buying during the financial crisis. find out more Latin America’s inflationary pressure contrasts sharply with Asia’s emerging nations, where central banks are mainly on hold and demand is sluggish while economies recover from the pandemic. find out more Markets now predict interest rates in Brazil to be higher at the end of the year than they were at the end of 2019, before the COVID-19 lockdowns and when inflation pressures were tougher to come by. After its first boost since 2018, Mexico is likely to raise rates by more than 1.25 percentage points, or 125 basis points (bps), before the end of the year. Despite confounding expectations with a dovish statement following the most recent central bank meeting, Colombia is expected to hike rates by over 150 basis points by the end of the year. “Some central banks may have to raise rates further than they were prior to the COVID shock, given that the COVID shock coincided with much higher commodity prices and lower currencies, a rare combination,” said Gustavo Medeiros, deputy head of research at emerging markets-focused fund manager Ashmore in London. “This suggests that these inflationary pressures going forward will be substantially weaker,” he said, referring to the trend of sinking currencies. Consider the following example: The Brazilian real plummeted over 8% in the first quarter, making it one of the weakest major currencies at the start of the year, but rallied to be the best performer in the second quarter, gaining more than 13%. Brazil’s central bank, which is currently one of the most hawkish in the emerging world, is partly to blame for the fast turnaround. The central bank’s rate-setting Copom committee had a policy of forward guidance at the start of the year, indicating that the benchmark Selic rate would remain at that level. In March, Copom raised interest rates for the first time in nearly six years, owing to higher-than-expected inflation. It hasn’t looked back since, raising rates by 75 basis points to 4.25 percent at each of its next two meetings and even considering a higher rise at its June meeting. “Inflation pressures have arisen first in developing markets as the global economy recovers swiftly,” credit-rating firm S&P said this week, highlighting Brazil’s monetary policy tightening. “By the end of the year, more Latin American countries are likely to follow suit.” Last week, Economy Minister Paulo Guedes stated that the real has “far more room to strengthen.” Analysts believe that if a stronger currency may reduce inflationary pressures, Copom may be given some freedom on interest rates. MANAGING EXPECTATIONSA rapid recovery in demand, firmer terms of trade, rising inflation, and a “very low” nominal policy rate “suggest the commencement of a gradual process of monetary policy normalization” in Chile, according to Alberto Ramos, Goldman Sachs’ head of Latin America economics. Chilean policymakers considered raising rates in June, raising the chances of an initial hike this month. Markets forecast the primary rate, which is currently 0.5 percent, to rise to roughly 2% by the end of the year, higher than the pre-COVID 1.75 percent. Last week, Mexico increased its key rate by 25 basis points to 4.25 percent, raising the prospect of more increases. For the time being, the market has priced in 110 basis points more hikes by the end of the year. In mid-June, year-on-year inflation in Mexico stood at 6%, more than double the central bank’s target of 3%. Colombia’s central bank is perceived as having a softer slope to climb than other countries, where inflation pressures have remained mild despite a crushing COVID-related surge in unemployment and the currency has dropped over 9% this year. “Colombia’s inflation prognosis is more favorable, and it has been so for some time. As a result, they have more time to respond “Mauro Roca, managing director of emerging markets sovereign research at investment management firm TCW, agreed. “Even in that situation, a more hawkish tone is envisaged in preparation for liftoff later this year.” Whether through more hawkish rhetoric or actual hikes, managing expectations will be critical to maintaining the credibility of the region’s central banks. “Much of the macroeconomic health of the region’s countries will depend on the credibility that their central banks can give to market,” Institute of International Finance analyst Jonathan Fortun told Reuters. “In the past, failure to do so has resulted in very terrible consequences in the region.” Abraham Gonzales in Mexico City, Rodrigo Campos in New York, and Jamie McGeever in Brasilia contributed reporting; Christian Plumb and William Mallard edited the piece. The Thomson Reuters Trust Principles are our standards./nRead More

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