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While policymakers at the US Federal Reserve are having a lengthy discussion about the pros and cons of withdrawing their billion-dollar pandemic stimulus, the debate south of the border is already over.
Inflation is back with a vengeance and Latin American central banks are raising rates, some aggressively.
Brazil is leading the way, with the newly independent central bank struggling to prevent inflation from hitting double digits. “Brazil really had a very big inflation shock,” said central bank governor Roberto Campos Neto allowed on September 1. Days later, figures were published showing annual headline inflation with a five-year high of 9.7 percent in August.
Brazil has raised its reference rate four times to 5.25 percent four times since March and investors expect another rise of at least 1 percentage point this month, with even more.
Inflation is of particular concern in Latin America due to the long history of price instability in the region, especially in the 1970s and 1980s. Newly empowered central banks have brought prices under control in most of the major economies over the past two decades, but the region has never completely driven out its inflation demons.
Venezuela had the worst inflation in the world at 5,500 percent in 2020 and prices in Argentina are rising more than 50 percent a year as the central bank happily pushes money to finance a deficit – another bad old Latin American habit.
In Mexico, core prices rose at the highest rate since 1999 last month and Citibank expects inflation for 2021 of 6.1 percent. Although the central bank never lowered the interest rate as aggressively as its peers during the pandemic, it tightened its policy twice this year and Citi expects two more increases before the end of the year, which will take the interest rate to 5 percent.
The same story is repeated along with the Andes. Annual inflation in Chile reached 4.8 percent in August, almost double the February level. The central bank has published a hawkish inflation report, indicating a further tightening after interest rates doubled last month. In neighboring Peru, inflation reached 4.95 percent in August and the central bank began to tighten, while prices in Colombia rose by 4.4 percent a year in August.
“The picture is getting uglier by the day with the rapidly spreading inflationary pressures,” said Alberto Ramos, head of the Latin American economy at Goldman Sachs. “It will probably take a significant policy sharpening to put the inflation genius back in the lamp.”
Latin America has been hit harder by the combined health and economic impact of coronavirus than in any other region. Rapidly rising interest rates are now threatening to suffocate a recovery that is already losing steam as government stimulus programs decline and commodity export prices decline. JPMorgan expects growth to slow from 6.4 percent in the region this year to just 2.4 percent next year.
“Central banks in the region have no choice,” said Ernesto Revilla, head of the Latin American economy at Citibank. ‘They need to tighten monetary policy despite a weak economy, because they cannot allow inflation expectations to stray. This is the curse of central banks in emerging markets ”.
Latin American policymakers are casting envious glances at the US, where the Fed has so far been able to continue its trillion-dollar economic stimulus, despite the fact that inflation peaked in July at 13 years.
“The Fed can continue to say that inflation is transient and that there is no need to overreact,” said Claudio Irigoyen, head of the Latin American economy at Bank of America. ‘Eventually it will pay a price, but the reality is that the world pays in dollars. . . Latin American central banks do not have the luxury of saying ‘this is a temporary change in inflation’.
The growing threat of inflation comes before an election cycle in which new presidents will be elected in the next 13 months in Chile, Colombia and Brazil, while Peru and Ecuador elected new leaders earlier this year. Voters are venting their anger over pandemic misconduct among incumbents and favoring radical outsiders, a dynamic that is a bad prospect for central banks.
The rate hikes in the Banco de Mexico have already sparked a political dispute with populist President Andrés Manuel López Obrador. ‘Although the Banco de Mexico needs to pay attention to inflation and growth. . . They have only been dealing with inflation for a long time, ” he said at his morning news conference last month.
Irigoyen said he had a “good chance” for more radicalization in the upcoming election. “This will put a lot of pressure on currencies and a demand for high spending, which will put pressure on central banks,” he added. ‘In the US, more and more people are claiming that the Fed needs to accommodate fiscal deficits. People in Latin America will say ‘if they can do it, why can we not?’