• Inflation, and more aggressive policy responses to persistent price pressures, continue to impart shocks to the global economy. Latam countries are not immune to these effects.
  • Yet, despite the increase in risks, economic recoveries in the region remain on track. Scotiabank economists see growth moderating to broadly pre-pandemic levels and inflation gradually returning to target.

Things aren’t getting any easier for Latam policymakers. Two weeks ago, financial markets were rocked by aggressive policy actions by major central banks (and the promise of more to come, if necessary) to contain inflation. A week ago, Colombia elected the leftist candidate, Gustavo Petro, in a result that repudiated traditional politics and especially the long tradition of electing conservative candidates. The election completes a Quadfecta of populist presidents in the Pacific Alliance countries and focuses attention on the new populist macroeconomics in the region. And now come reports that advanced economy central bankers are warning that the era of low inflation, low interest rates is over. The shocks just keep coming.

That latest piece of news is somewhat disconcerting if for no other reason than central banks are not entirely impotent when it comes to inflation. They can do something about it, after all. Of course, achieving inflation targets is more challenging in the face of supply-side shocks, which is exactly what central banks in the Latam region and around the world have confronted over the past year.

So, on the one hand, are the central bankers signalling that they expect a continuing string of supply shocks from the realization of geopolitical (and other) risks, or that the output costs of returning inflation to target in the short run are too high? Neither option is particularly encouraging; for Latam policy makers, the challenges mount.

On the other hand, however, these are the same central bankers who insisted not that long ago that the uptick in inflation was transitory. This is not intended as a criticism. At the time, the case for a temporary upsurge of inflation coming out of the pandemic was strong. They can’t be blamed for not anticipating the extent and duration of shocks to global supply chains, though in hindsight some disruptions should have been expected. Regardless, central bankers certainly can’t be blamed for not guessing the Kremlin’s intentions. As noted, the shocks just keep coming. It is not surprising, then, that inflation has become a lot more persistent.

KEY ECONOMIC CHARTS

Despite the uncertain environment these shocks create, and the increased risk of recession that more aggressive monetary policy responses to higher inflation elicit, the economic recovery remains on track across the Latam region. Scotiabank teams expect real GDP growth to moderate to pre-pandemic levels (chart 1), as output and employment levels return to where they were before the pandemic struck. New information coming in from monthly indicators is consistent with this outlook, with Colombia activity indicators signalling continued recovery and a range of indicators pointing to robust monthly GDP growth in May in Chile. That said, with unemployment rates rising in Chile and Mexico, and heightened risks, there is no grounds for complacency. In this context, high-frequency monthly activity indicators (chart 2) should be closely monitored for nascent signs of a stalling economy.

With headline inflation running above central banks’ inflation targets (chart 3), this remains the number one policy priority across the region. Nevertheless, central bank commitments to price stability remain strong, and the actions taken to keep inflation expectations firmly moored lead our country teams to anticipate a gradual return of inflation to target over the coming year. Mexico’s Banxico recently raised rates, hiking its key policy rate 75 basis points, while Colombia’s BanRep raised its policy rate 150 bps on June 30th. Meanwhile, minutes of the last meeting of Chile’s BCCh show that it considered a more aggressive 100 bps hike, but likewise opted for an increase of 75 bps. With the higher rates Latam central banks have put in place, policy rates are now positive in real (after inflation) terms (chart 4). In this regard, the proactive response by the region’s central bankers stands out in comparison to their global peers (chart 5).

Strong economic growth in 2021 and 2022 has reduced large pandemic-related deficits (chart 6). As noted previously, fiscal consolidation in Peru has been especially impressive, though this may be a reflection of an inability of the government to execute spending plans rather than a well thought fiscal strategy. Colombia’s public finances have likewise improved significantly. The election of a new president with ambitious spending plans increases uncertainty, though our team in Bogota view the announcement of a steady pair of hands to fill the Finance Minister portfolio as market friendly much faster than anticipated.

Improved fiscal outlooks are critical to insulating the region from additional external shocks transmitted via global financial markets. Lowering debt-to-GDP ratios (chart 7) and reducing external debt burdens (chart 8) would likewise provide a confidence boost to investors anxiously watching external financial conditions. Moreover, sound public finances would also rein in large current account deficits (chart 9) and bolster international reserves that serve as a buffer to external shocks.

KEY MARKET CHARTS

Regional financial markets, which largely outperformed other emerging markets through the first half of 2022 have come under increased stress more recently as the US dollar has appreciated against most currencies. While some remain up against the US dollar since the start of year (chart 3), others have seen steep depreciations more recently. In Chile, the depreciation of the peso and the potential pass-through effects on higher inflation led our team in Santiago to predict policy action—foreign exchange sales and/or moves by BCCh. It was a prescient and timely call. As it turned out, the threshold was crossed, triggering FX sales. Many regional equities markets are down on the year, as the global (and domestic) shocks have weighed on markets. These movements should be viewed in the context of volatile global markets (chart 4). Such uncertainty may be reflected in exchange rates (chart 5) and CDS spreads on Latam sovereign bonds (chart 6), which have waxed and waned in response to indications of greater or lesser uncertainty.

YIELD CURVES

Most yield curves across the region are now inverted or flat (charts 1–20). As noted in previous editions of the Latam Charts, this could be an early indicator of recession, albeit one that should not be given inordinate weight. Colombia and Peru are the exceptions here, as they have been through the yield curve inversion in regional partners.

KEY COVID-19 CHARTS

Jurisdictions around the world are easing masking and vaccine requirements as the COVID-19 virus fades from public consciousness, if not public health concerns. Key monitoring charts for what remains a potential threat to public health and economic health are provided below.


LOCAL MARKET COVERAGE
CHILE  
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Coverage: Spanish and English
   
COLOMBIA  
Website: Forthcoming
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Coverage: Spanish and English
   
MEXICO  
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Coverage: Spanish
   
PERU  
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Coverage: Spanish
   
COSTA RICA  
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Subscribe: estudios.economicos@scotiabank.com
Coverage: Spanish

 

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