Latin America's Inflation Woes Are Growing

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by: LATAM PM

Summary

Despite a global downturn in commodity prices, inflation in most Latin American countries is picking up. Mexico and Costa Rica were the only regional outliers in 2015.

Annual inflation in April: Brazil 9.28%, Colombia 7.93%, Chile 4.20%, Peru 3.91%, Mexico 2.54%.

Inflation in Venezuela was 270.7% in 2015. Recent electricity, food, and medicine shortages will drive prices further up.

Despite a global downturn in commodity prices, inflation in most Latin American countries is picking up. Mexico and Costa Rica were the only regional outliers in 2015, but still, an uptick is expected for both in 2016. Higher consumer prices have already hastened monetary tightening in some countries, a no-no in a recessionary economic environment. Why is inflation increasing? How are central banks responding? We analyzed consumer price dynamics in selected LatAm countries.

Brazil: Inflation in Latin America's biggest economy accelerated throughout 2015 and shows no sign of short-term relief. Central bank data shows that consumer prices closed last year at +10.67% year on year, their fastest pace in thirteen years. The annual inflation rate for April 2016 was 9.28%. The rate is well above the official target of 4.5% ±2%. The last Brazilian Central Bank (BCB) survey showed that economists expect consumer prices to end this year at 7.04%. This means the BCB would have failed to meet the official target for a second straight year. Market participants' and policymakers' concerns are intensifying - the central bank's minutes revealed that monetary easing is practically discarded. Three key factors are currently affecting price dynamics: the real's massive depreciation, distorting wage-indexation mechanisms, and sticky gasoline prices - which impede adjusting tariffs to reflect declining oil costs. The decision to hold the Selic rates unchanged has already raised questions of central bank autonomy. Credibility is at stake.

Mexico: Consumer prices have been declining over the past twelve months to a rate as low as 2.13% year on year, a new record low. This was a major achievement for the central bank, which has a 3% ±1% target and had failed to meet the target last year. The consumer price index (INPC) ended 2014 up 4.08%, compared with 3.97% in 2013. The absence of demand-driven price pressures, lower telecom tariffs and low crude oil prices contributed to inflation dynamics throughout 2015. However, harder comps and fiscal vulnerability make it unlikely that the official tariffs will keep declining. Consumption dynamics are picking up, but will hardly bring significant demand-side pressure. And while the peso's depreciation has had limited pass-through, a prolonged weak currency will affect inflation at some point. The last CB minutes reflected this concern. With these forces in play, market participants are currently pricing an upswing for the next twelve months. The last Banco de Mexico (central bank) survey showed that analysts expect inflation to close the year at 3.19%, which is still within the CB's target range and more than welcome. With the annual headline reading coming at 2.54% YoY, Mexico remains as our sample outlier in terms of inflation. Check more details on our vision of the Mexican economy and the bullish ETF.

Colombia: The inflation outlook has sharply deteriorated in the last months. Consumer prices increased in April by 7.93% YoY. Inflation has remained above the upper limit of the bank's target range for the last 15 months. It stood at 4.46% back in July and at 3.82% in January 2015. The surge in prices prompted monetary authorities to activate a tightening cycle. The central bank of Colombia raised its benchmark interest rate by 50 bps to 7 percent on April 29th 2016, above market expectations of a 25 bps increase. The rate was set at 4.50% back in September 2015. The peso's depreciation and a spike in food-related inflation resulting from the El Niño weather shock and indexation schemes were the primary drivers of price pressures. Beans, cereals and fruit crop supplies were all affected by El Niño. Inflation convergence to the target of 3% ±1% seems highly unlikely this year. A prolonged monetary tightening cycle could be seen if transitory shocks like El Niño or the massive peso depreciation dissipate as expected by the central bank. In negative news, expectations have deteriorated sharply, at 6.03% for December 2016 inflation (April poll) vs. 4.83% (December poll), according to the latest central bank survey.

Chile: Exchange rate depreciation remains the core driver of inflation and deviation from the officially established inflation target range of 3% ± 1%. Inflation has exceeded expectations, with the consumer price index (IPC) now standing at 4.2% year on year. It is noteworthy that core inflation is higher than the headline reading, approaching 5%. Food and non-alcoholic beverages prices - 19% of the IPC - have been significantly affected by El Niño and currency depreciation. The peso tumbled 14.7% against the U.S. dollar in 2015. The central bank has shown concern regarding inflation standing above target. It adjusted its inflation forecasts for 2016 from 3.7% to 3.8%, citing foreign exchange depreciation as the prime factor behind price pressures. After keeping the benchmark monetary rate unchanged for 12 months, the central bank hiked 25 basis points to 3.25%. It repeated the move in December to leave the rate at 3.50%. The Central Bank of Chile left its benchmark interest rate unchanged at 3.5 percent at its April 2016. Weak domestic consumption and a steep decline in copper exports make it unlikely that inflation will remain above 4% for a prolonged period. Moreover, the central bank's credibility is among the highest in the region, and expectations remain anchored. According to the last central bank survey, market participants still expect inflation to close 2016 at 3.50%, which is within the target range. They also expect a hike of 50 basis points throughout the year. Policymakers are aware of this and will continue with a hawkish stance to prevent further deterioration of expectations.

Peru: This is another country hit by the El Niño weather effect and by and pass-through inertia from currency depreciation. However, supply-side shocks also include electricity price adjustments (of about 18.7% in the last twelve months), partially explained by currency effects. Headline inflation reached 4.4% year on year at the end of 2015. Food and beverages prices stood at 5.37% in December. However, inflation has abated since and currently stands at 3.91%. The central bank (BCR) has a target of 2% ±1%, and has shown concern about inflation standing above the range. Central bank president Julio Velarde has been vocal about refineries not adjusting the price of gasoline downwards to reflect the downturn in oil costs. According to the latest central bank survey, expectations for December 2016 inflation deteriorated throughout the year, changing from 2.6% in January 2015 to 3.4% in December 2015. The Central Reserve Bank of Peru, in February, raised its reference interest rate by 25 basis points to 4.25%, the third straight month of tightening. The moves have been effective, and consensus does not expect much central bank activity ahead.

Argentina: Macri assumed office in December and declared a "statistical emergency" in his first month to rebuild the data agency and replace a consumer price index created in 2014 by the Kirchner administration. The country won't publish most of its statistics for several months. The government is now using a CPI from the city of Buenos Aires. At 26.9%, inflation is nearly double the national rate reported by the previous administration. Macri has reiterated his commitment to bring inflation down to 20-25% this year and to single digits by the end of his term. So far, his first actions in government have been congruent with this goal, but the peso's devaluation could bring pass-through inflation in the next months. In January 2016, IMF's Western Hemisphere director, Alejandro Werner, said that Argentina "has started an important transition to correct macroeconomic imbalances and microeconomic distortion." He also showed willingness to begin working with the INDEC statistics bureau to lift the motion of censure placed on Argentina. All of these steps will help curb inflation expectations. We are still expecting complete and credible official data to have an informed opinion.

Venezuela: The bad news is that the IMF forecasts inflation will reach an annual pace of 720% this year. In more bad news, recent electricity, food, medicine shortages could drive prices further up. Good news: There is hardly any. Inflation closed 2015 at 270.7% (no typo), according to central bank data. It is the highest inflation in Venezuela's history. But the figure could be worse. IMF's Western Hemisphere director, Alejandro Werner, published a note saying that inflation for 2015 was 275%. Werner said, "a lack of hard currency has led to scarcity of intermediate goods and to widespread shortages of essential goods - including food - exacting a tragic toll." He added that "prices continue to spiral out of control." After that, the IMF's WEO (April 2016) showed that the multilateral organization expects inflation in Venezuela to reach 2,200% in 2017! (No typo, again.) It is difficult to assess if the country will experience a tragic episode of hyperinflation. While demand-side pressures are null, supply shortages will likely continue. Complete lack of central bank autonomy and credibility is an understatement. Policymakers need to correct distortions soon, before inflation (and many other economic variables) gets out of control.

LATAM PM's View

Mexico is a regional outperformer in converging to the official inflation target, strongly aided by structural reforms, frozen gasoline prices and a persistent slack in the economy. The Pacific Alliance bloc (Colombia, Chile and Peru) suffered from currency depreciation and the El Niño effect. Price stickiness has impeded consumers in these countries from benefiting from plunging oil prices. Most economies opted to begin the monetary tightening phase well in advance of the Fed (Banco de Mexico being the exception). Peru's tightening cycle proved effective and might have come to an end (the last move was in February).

Colombia has been the most hawkish central bank thus far. Brazil is being affected by structurally embedded indexation practices, stickiness of energy prices, and massive currency depreciation. It is noteworthy that recessions in Brazil and Venezuela have not prevented inflation from escalating. As seen in other Latin American economies, supply-side factors are the main forces behind inflation upswings - some of them transitory, like the El Niño weather effect, but some not, like the stickiness of energy prices. Although demand-side pressures will be practically non-existent throughout 2016, more currency depreciation could bring more rounds of monetary tightening - a policy calamity in an environment of weak global demand and plunging commodity prices.

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