News | Question of the Week, WC 20th Jan 2020
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Q: Will the BCB and Banxico cut interest rates further despite the January inflation rebound in both countries?
A: Our base case is that both central banks will be able to cut interest rates over their coming meetings. Brazilian inflation is off to a bad start this year, but January's jump is not the start of an uptrend, and we think better news is coming. The January mid-month IPCA-15 index rose an unadjusted 0.7% month-to-month, in line with market expectations. This was the biggest gain for January since 2016, but the rebound is due mainly to temporary shocks. The year-over-year rate rose to 4.3%, from 3.9% in December, also in line with Bloomberg's consensus. But underlying pressures are modest, reflecting favourable financial conditions, the ample output gap and still-modest domestic demand growth. As a result, inflation expectations remain anchored. These factors, coupled with the weakness of the labour market—though it is now improving—and favourable inertia, indicate that more stimulus will be forthcoming from the BCB. Our view is that policymakers will cut rates by 25bp in both February and March, leaving rates at 4.0%.
In Mexico, meanwhile, inflation started the year on a disappointing note, but the underlying picture is improving. The advance CPI report showed that inflation is under control, despite temporary shocks, including higher taxes. Consumer prices rose 0.3% month-to-month unadjusted in the first two weeks of January, thanks mainly to the non-core component. The year-over-year rate rose to 3.2% in January, from 3.0% in December. This increase likely will be short-lived. Domestic demand lost momentum during the second half of last year, on the back of falling confidence and tighter fiscal and monetary policy. The slowdown should exert downward pressure on inflation in the second half of this year, and we expect it to return to the middle of Banxico's 2-to-4% target range. Our case is that Banxico will be able to cut interest rates over the coming meetings, to 6% from 7.75% now. The economy is under severe strain and inflation pressures are low.
Chief LatAm Economist
Posted: 24th Jan 2020
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