Alphacast Highlight - Central Banks reacted strongly to higher inflation rates
By Maia Mindel (mmindel@alphacast.io)
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Inflation in Latin America, rapidly accelerated in 2021 and 2022 after the deflationary slowdown in 2020, as a result of both increased demand after stimulative monetary and fiscal policies, and of supply factors ranging from international shipping delays to a commodity price shock given the events in Eastern Europe. The region's highest inflation rate is Argentina's 78.5%, which follows the country's singular price dynamics and economic policies. Meanwhile, the rest of the region is experiencing high inflation rates, led by Chile's 14.1% YoY, Paraguay's 10.5%, Colombia's 10.2%, Brazil's 8.8%, Mexico's 8.7%, and Peru's 8.4%. Ecuador, which has adopted the US dollar as its currency, is experiencing a lower inflation rate of 3.8%, and Bolivian price growth has barely budged - to 1.6% a year even in the most inflationary global environment in half a century. Following this spike in price growth, the region's Central Banks have embarked on an aggressive tightening cycle, as in the rest of the world.
In response to the newly inflationary global context, central banks have raised rates to their highest levels in years, and in some cases decades. This rapid tightening of financial conditions serves dual functions: to cool down a clearly overheated economy, and to preserve the monetary authorities' own credibility in their most challenging environments in recent memory, Compared to developed nations' central banks, such as the Fed and the ECB (which have tightened from 0% to 3% territory), Latin American banks began tightening earlier, and have tightened by a much higher degree as well - a difference that is likely to be attributable to a higher level of concern over credibility and reputation.
Argentina has had an unusual trajectory given its unique inflation dynamics. While the acceleration of inflation is in line with the rest of the region, Argentina's inflation rate rose from 51% YoY in December to 78.5% in August, the highest levels since the end of hyperinflation in the early 1990s. The country's central bank has reacted similarly to others in the region, by raising the policy rate from 38% in January to as much as 75% in October, but the sheer level of nominality in the economy, as well as the wholly unanchored nature of inflation expectations, means that nothing less than a whole-of-government approach to resolving the economy's systemic issues will reduce prices considerably. Real interest rates, however, remain heavily negative, with an effective rate of nearly -20%.
The Chilean central bank's moves have been particularly aggressive, raising the policy rate from 0.5% in October 2021 to over 10% last month. This rapid rise could be explained by both the nation's extraordinarily high inflation rates (14.1% YoY in August, second only to Argentina's 77.1%), as well as its complex political context, with a major rethinking of the country's economic institutions under way. Even though nominal interest rates are significantly higher, they are still below the inflation rate, as seen in negative real rates over the past few months.
Brazil has seen a declining inflation rate as of late, from a peak of 12.7% YoY in April to 8.7% recently, primarily due to reductions in fuel taxes to ameliorate the effects of higher prices. At the same time, the region's largest economy has embarked on an early and ambitious hiking cycle, raising rates the soonest of all major economies (in mid March) and having the highest rates after Argentina - the policy rate rose from 2% in August to 13.75% at the moment. The aggresiveness of Brazil's monetary policy has resulted in it being the only major economy in the region with positive real interest rates, at a 7.8% effective annual rate.
Mexico has seen a more moderate price growth trajectory, with inflation accelerating less steeply over 2022 - from 7.7% YoY in January to 8.7% in August. This more moderate price path has resulted in a less aggressively contractionary policy path as well, since interest rates rose steeply but to a lower level: from 5.5% in January to 8.5% in October, among the mildest tightening cycles in the region. Even then, Mexico's policy rates were barely negative in August, with the effective interest rate at just -0.8%, the least low value after Brazil's positive rate. Banxico's long track record of stabilization might have played a role in their reduced vulnerability to an inflationary spike in 2022.
Peru and Colombia have shown similar dynamics over the past two years, with both seeing inflation rapidly accelerate from the 2% to 2.5% range in mid 2021 to significantly higher values (6.4% and 5.3% respectively) over just a few months, and growing even further to values in the 9% range by mid 2022 as well. In response, both central banks raised their policy rates by the third quarter of 2022, with Peru beginning to tighten in August and Colombia in September. The policies adopted were as contractionary as those of Chile, but outcomes have been divergent: just as Chile, Colombia's inflation continued climbing upwards in 2022, while Peruvian inflation rate began slowing in June. The Colombian policy rate was sharply negative (-4.4%) in August, and it's highly likely Peru's is at a similar (or slightly lower) level as well.
Uruguay has not buckled the trend, even though its its inflation rate was among the most stable in the region, at a steady 8% to 9% YoY throughout this period. At the same time as this relative stability, the Uruguayan monetary authority embarked on a more contractionary policy as well, with the policy rate growing from 4.50% in August 2021 to 10.5% presently. The relationship between policy over the last 13 months and the present situation might be hard to determine, but it's likely that Uruguay's early tightening cycle might have stabilized the currency.
Higher price growth has not manifested itself equally though: expectations in Argentina seem completely untethered from the government's objectives, and have nearly doubled since January, from 53.9% YoY to 90.5% YoY in August. Meanwhile, expectations in Peru and Colombia have edged upwards from a 4% rate in February to nearly 7% in August, reflecting the impact of recent price increases on consumer expectations. In general, and outside of Argentina, consumers seem to expect prices to be only transitorily higher, as shown by longer term expectations returning to trend in the medium term, meaning that they do not seriously question their authorities' commitment to price stability.
The monetary panorama is complex, both at the global and regional levels. While supply-side issues seem to be subsiding, the demand overhang from the 2020 and 2021 stimulus packages might remain an influential source of disruptions. Central banks in Latin America have acted early and decisively to tame the highest inflation in recent years, and are deploying a credible and well-tested playbook to do so. At the same time, contractionary monetary policy poses its own challenges to the economy at large, particularly concerning the risks of another downturn. Regardless, inflation remains the main challenge for the region, and monetary authorities are taking it with the seriousness it merits.
