Latin America should conclude the cycle of high interest rates still this year, says XP

The global effort by central banks to control skyrocketing inflation has led to an unprecedented increase in interest rates around the world, which is likely to cause a sharp slowdown in economic activity.

In Latin America, inflation continues in an upward trend and with continuous surprises, which has made different institutions revise their projections upwards. That is the case of XP, which sees a pressured inflation and no signs of relief in the region.

In a report released on Monday, September 19, exclusively to Bloomberg Linea, XP highlighted that inflation in major Latin American countries continued on an upward trend, reflecting continued pressures from high commodity prices, bottlenecks in production chains, and still high aggregate demand.

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 strongly contribute to prices, 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,” write the authors of the study Francisco Nobre, an economist at XP, and Andres Pardo, head of the macroeconomic strategy for Latin America.

Except for Brazil, which has already entered a disinflation process, XP raised the inflation projections for the other Latin American economies.

However, the economists reinforce that they have not abandoned the expectations that the global disinflation process will still start in this second semester.

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.

“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 easing 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 of production chains contribute to global disinflation.

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

BRAZIL: PROJECTIONS IMPROVE DESPITE UNCERTAIN WORLD AND ELECTIONS

Three weeks before the presidential election, XP highlights that the fiscal challenge in Brazil is significant, as well as the demand for structural reforms.

With the perspective that the economy will continue to recover, the company again raised the projection of Gross Domestic Product (GDP) growth this year from 2.2% to 2.8%. For 2023, the forecast for the expansion of activity rose from 0.5% to 1%.

Under the effect of tax reductions and benefiting from the global decompression of costs, inflation has been falling in the country, and the IPCA registered deflation in July and August.

For this year, XP estimates a high of 6.1% for the IPCA (compared to 6.8%), while for 2023, the projection is now 5.3% (compared to 5.5%).

According to Nobre and Pardo, the Central Bank should interrupt the monetary tightening cycle with inflation expectations stabilizing.

“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 fiscal policy in 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 AND HIGHER INTEREST RATES

In August, inflation in Mexico came in higher than expected, suggesting continued pressures.

The Consumer Price Index (CPI) advanced 0.7% in the month, with monthly variations running above the range of the last ten years.

Thus, the accumulated inflation in 12 months advanced from 8.15% in July to 8.7% in August, marking the highest increase since April 2021.

In the report, XP highlights that inflation in Mexico is historically high but below the peak of inflation in other countries.

With continued pressures, the team revised its inflation projections for the end of 2022 from 8.2% to 8.5%. The estimate for the end of 2023 is for a 5.3% rise in inflation in the country.

“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 (we previously projected 0.50pp), which would take interest rates to 9.25%,” writes XP.

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

CHILE: DISCOUNTED ASSETS, REFLECTING DOMESTIC AND INTERNATIONAL RISKS

Inflation in Chile is among the highest in Latin America. The consumer price index (CPI) advanced by 1.2% in August, above market expectations, and marked the sixth trip above 1% in the first eight months of the year.

XP evaluates that the disinflation process in Chile will gain traction in the second semester but at a slower pace.

The analysts revised the inflation projections for the end of 2022 from 11.5% to 12.3%. With the disinflation process accelerating next year, the projection is that inflation will end in 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 positively impact 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.

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, estimates rose from 5.8% to 6.1%.

The assessment is that BanRep (Colombia’s central bank) is expected to maintain an accelerated pace of hikes but 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 economist duo highlights.

The house maintains the 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% (from 10% previously).

With information from Bloomberg