Colombia and Mexico face pressure to accelerate interest rate hikes

RIO DE JANEIRO, BRAZIL – Investors are betting that the two central banks lagging behind Latin America’s eagerness to raise interest rates are ready to pick up the pace.

As inflation accelerates, monetary policymakers in Colombia and Mexico are under increasing pressure to raise borrowing costs higher and faster. While the specific determinants of price pressures vary across countries, swap dealers are increasingly convinced that both will join their regional peers in embarking on more aggressive monetary tightening.

Read also: Check our coverage on Colombia and Mexico

Any change in strategy would be something of a capitulation for both monetary authorities, which have been trying to find a balance that would allow them to support economic recovery from the pandemic and control inflation that is rising at its fastest pace in nearly four years. Like monetary policymakers worldwide, officials in Mexico and Colombia are increasingly concerned that price pressures are more persistent than they had anticipated.

“Inflation is proving not to be as transitory as central bankers initially thought,” said Brendan McKenna, a strategist at Wells Fargo in New York. “I’m not entirely surprised to see markets discounting higher interest rates in both countries.”

In Colombia, which on Sept. 30 raised its cost of borrowing for the first time in five years, contracts that allow traders to bet on interest rates have moved up along the curve and now indicate a doubling of the benchmark rate over the next six months.

Mexican swaps indicate that rates will rise back to pre-pandemic levels in early 2023, and traders are increasing their bets after this month’s surprise vote by Banxico’s newest member to raise interest rates.

Both countries still have a long way to catch up with their regional peers on rate hikes. Peru and Chile have raised rates by at least a percentage point this year, while Brazil has raised rates by 425 basis points. Mexico, which already has one of the highest rates in the region, has increased rates by 75 basis points and Colombia by only 25 basis points.

In September, four members of Colombia’s central bank board voted to raise borrowing costs by a quarter-point to 2%, while three voted for a half-point increase. Traders are discounting two more hikes of 50 basis points each at upcoming meetings to bring the benchmark rate to 3% by year-end. They expect the rate to reach 5.5% by the end of 2022.

In September, annual inflation accelerated to 4.5%, the fastest pace in four years and above the bank’s 3% target, driven by food, rent, and fuel prices.

Monetary policymakers may see more room to raise rates as economic growth accelerates. The central bank began the year forecasting gross domestic product growth of 4.5% in 2021 and upgraded that projection later in the year to 8.6%, the fastest growth rate seen in at least 50 years.

In Mexico, the benchmark rate of 4.75% is the second-highest in the region, after only Brazil. But traders who had been preparing for what they thought would be a shift to a moderate stance from the central bank when former Finance Secretary Arturo Herrera takes over in January are reassessing that outlook.

While Herrera was chosen in an attempt by President Andres Manuel Lopez Obrador to appoint a “moral” economist who could prioritize the economy and employment, analysts say the reality of 6% inflation will keep monetary policymakers on their toes.

For now, all eyes are on the newest member of the five-person board, Deputy Governor Galia Borja. Also nominated by Lopez Obrador, Borja surprised Banxico watchers when she joined the consensus for a rate hike last week in the bank’s decision that raised the benchmark rate to 4.75%. The final tally was four members in favor of a 25 basis point increase with one rejection.

“Borja has become the most important person on the board,” said Benito Berber, head of economics for Latin America at Natixis in New York. “Borja could help those with a restrictive stance on this process regardless of how the new governor Herrera votes.”

Previously, Berber expected only one or two rate hikes from the central bank before a pause after Herrera took office. Now, with the Fed likely to withdraw its stimulus in the coming months and Borja taking a tightening stance, he says the central bank could hike as much as 125 basis points between now and the end of 2022.

Danny Fang, a strategist at Banco Bilbao Vizcaya Argentaria SA in New York, said Mexico started its rate-hike cycle earlier. Colombia has lower inflation and, therefore, more time to react. Monetary policymakers in both countries feel pressure to become more aggressive.

“Both central banks look at similar things with respect to growth versus inflation versus financial markets,” Fang said, “However, the macro circumstances are a little different, so their priorities are a little different.”