Latin America rate hike pressure grows as Chile signals lift-off

A shift toward tighter monetary policy is quickly taking shape across Latin America, with Chile signalling it is ready to raise its benchmark interest rate from a record low as soon as July.

Chilean policy makers considered lifting borrowing costs by 25 basis points this month as the economic recovery gains steam, according to the minutes to the June rate-setting meeting published on Wednesday. Brazil said this week it may opt for quicker monetary tightening going forward, while faster inflation in Mexico and Colombia are raising prospects their central banks may also pare stimulus.

Latin America’s central banks are facing pressure for rate hikes as both global and domestic factors revive inflation. Policy makers have been stung by higher raw material costs and bottlenecks as the global economy reopens after virus-induced shutdowns. Emergency spending is boosting demand in places like Chile and Brazil, while Colombia has grappled with unrest that has hit supplies.

Chile’s Central Bank minutes show the debate has already shifted from increasing or not increasing rates to by how much and how fast. Pressure is increasing in Mexico, because headline and core inflation are high and have steadily surprised to the upside this year. Colombia’s headline inflation jumped in May but that was mainly due to disruptions caused by the protests and will be transitory. Core inflation is still low and the central bank will focus on that.
– Felipe Hernandez, Latin America Economist

Central banks played a crucial role in the region’s economic response to multiple waves of the coronavirus. Policy makers in countries including Brazil, Mexico, Colombia, Chile and Peru slashed their borrowing costs to multiyear or record lows in 2020 as the pandemic crushed demand and confidence.

Now, traders expect Brazil to lift borrowing costs by at least 100 basis points in August following three straight boosts of 75 basis points, eventually propelling the Selic over seven percent by year’s end. Mexico’s Central Bank will likely hold rates steady on Thursday, though the first hike is priced in for September and nearly 75 basis points of tightening is seen by December.

Colombian traders are pricing in a borrowing cost increase within the next two or three months, while Chilean swaps show the key rate rising by 25 basis points in July and a total of 150 basis points in six months.

Preparing markets

Chile’s macroeconomic outlook is improving on factors such as strong consumption, meaning such a high degree of monetary stimulus is no longer required, policy makers wrote in the minutes. The board added it needed to prepare financial markets “for the adjustments that would occur shortly.”

“Although the board considered it important to communicate the launching of the process of withdrawing the monetary stimulus, it also deemed it advisable to emphasize that monetary policy would remain expansionary for a long period of time,” policy makers wrote. The bank has held its key rate at a record low of 0.5 percent for over a year.

Chile’s central bank expects annual inflation to hit 4.4 percent in December, above the three percent target. It also sees gross domestic product expanding by as much as 9.5 percent this year on stronger domestic consumption and global demand.

Across Latin America, economic recoveries have been uneven and headwinds such as unemployment and virus flareups pose challenges to growth. Complicating matters further, some governments are running out of spending room, while political uncertainty and social unrest are risks going forward.

Still, pent-up demand is fuelling inflation rates that are already running above target in countries throughout the region, and may be slow to fall.

“Latin American central banks are turning more hawkish,” economists for Bank of America Corp including Claudio Irigoyen wrote in a research note this week. “Important risk events are already behind us, and the growth outlook has been improving.”