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Chile inflation surprise underscores growing regional problem

May 9, 2014

Falling Latin American currencies are pushing up inflation, but policy reactions are diverging, say analysts

     
     
   Source: Eneas de Troya  
Chile's official April inflation figure, released Thursday, held a nasty surprise for investors: a monthly rise of 0.6%, compared to market expectations of 0.2%, according to research from Credicorp Capital. The annual inflation figure is now at 4.3%, compared to 3.5% a month ago.

The news triggered a rally in the peso and interest rate swaps as investors changed their bets to a scenario where the central bank is forced to delay cutting rates below the current 4%. That is despite weaker than expected growth figures announced earlier in the week.

"It puts the central bank in a tricky situation," says Álvaro Vivanco, rates strategist at BBVA in New York, discussing the difficulties of tackling above-target inflation in an increasingly grim growth scenario.

With the exception of Mexico, inflation is worsening across the region. Inflation rose about 12% in April in aggregate across Latin America, according to Capital Economics. Stripping out Argentina and Venezuela the figure falls to 4.1% - still a sharp rise on the March figure of 3.1%.

Mexico was the only outlier: there inflation fell to 3.5% in April from 3.8% in March. "With policymakers seeing through recent price pressures, and economic growth taking longer to accelerate than anticipated, interest rate hikes in Mexico are becoming much less likely," said Capital Economics.

FX to blame

Food and energy are partly to blame for rising prices elsewhere in the region. But weaker exchange rates are also a factor, given the region's floating currencies have fallen over the past year, despite a recent rally, Capital Economics said in a research note.

More costly imports as a result of weaker exchange rates "appear to be aggravating inflation to some degree", according to the research note. "Given that we expect most currencies to weaken again over the coming months, this will remain a threat to the inflation outlook," said the note.

Yet despite the common threat of higher inflation, the macro-economic policy response in the region is increasing divergent - and far less focused on US rates policy - compared to six months ago, says Vivanco.

"Rates cycles have got out of sync," he says. "Policymakers are focusing more on domestic factors now."

As examples, Vivanco points to the contrast between Chile and Colombia. The latter surprised the market with a 25bp rate hike, to 3.5%, on April 25 and is trying to stave off further appreciation of the currency via increased daily interventions in the currency market. While Vivanco says Chile may now delay rate hikes, but could still end up hiking rates by another 50 bps before the end of the year.

He also notes the difference between Brazil's interventions to defend the currency, and Peru's concern to contain any depreciation of the currency, with Mexico's approach of keeping rates on hold, and letting the currency float.

"There is a lot of divergence compared to six months ago. Now policymakers in each country are doing their own thing." LF



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