Wider output gap set to curb FX pressures in Latin America

LatAm inflation is marked by divergent trends at present: upward in the small, open economies and downward in the larger countries with disappointing growth. 

In Brazil and Mexico, upward inflation pressures from weaker FX are being offset by below-par growth, leaving their central banks on hold.

In Brazil, August inflation printed just below expectations, increasing 0.22% m/m, while we were expecting a 0.25% print. Inflation is now 9.53% y/y, from 9.56% in July, and we believe that the downward trend should prevail in the next 11months. The release showed that food inflation was slightly negative (-0.01% m/m), after an unusual period of strong prints relative to the seasonal pattern between May and July. However, we believe this is only transitory. The weaker exchange rate since the end of August, already down 6.3%, should pressure food prices upwards again in the next two months. 

"In the medium term, however, our models suggest that there is a stronger counter-effect balancing this pressure: the long and deep recession that we forecast to continue in Brazil for the next three quarters," commented Barclays. "Our forecast of the USDBRL reaching 4.10 by the end of the next year adds 40bp of higher inflation in 2016. The stronger than expected regulated price adjustments and higher inflation expectations arising from the looser fiscal execution add another 50bp. In contrast, the wider negative output gap implied by our forecast of a 3.2% fall in real GDP this year, followed by a 1.5% contraction next year, decreases the inflation forecast by 90bp. That said, our forecast for 2016 inflation remains at 5.6%. "

In Mexico, inflation continues on a downward trend, unhindered by the depreciation of the MXN. Annual inflation fell to 2.5% in the second half of August, from 2.6% in the previous fortnight and 2.7% in July. Core inflation has stabilized at 2.30% for almost five consecutive months now, with durable goods inflation stable at 2.7% y/y. The trend of the core component has also stabilized and it is right on target (3.0% 3m/3m saar). This recent performance has pushed our year-end inflation forecast down to 2.5% y/y from 2.6% previously. 

"We estimate that core inflation will print at 0.30% m/m on average per month for the next four months, incorporating an important FX pass-through and implying an acceleration of the core component. However, weaker-than-expected demand could curb this performance," added Barclays.

Consensus is expecting a first hike by Banxico in the next meeting on September 21. 

"We do not believe that Banxico will hike as inflation continues to be on a downward trend, there are potential headwinds to growth and inflation expectations have not changed dramatically, even with the FX depreciation. On top of that, the government will be liberalizing gasoline prices next year, an event that definitely will have a positive impact on inflation dynamics in 2016. Retail prices in Mexico are around 20% higher than in the US, and we expect declines in prices next year. Under these circumstances, we continue to expect a first hike in December, when there will be more clarity about the effect of the FX depreciation on inflation expectations, any US Fed action and the potential magnitude of the rebound in inflation during January 2016."

The small, open economies such as Chile, Colombia and Peru, are experiencing a rise in y/y inflation, encouraging a tighter monetary policy. Growth in the large economies, such as Brazil and Mexico, continues to disappoint, serving as a cushion for the weaker exchange rate. Inflation has accelerated quite meaningfully in the past four months, which could necessitate tighter monetary policy amid relatively stable growth. 

In Chile, inflation reached 5.0% y/y in August after 4.0% by May, given another bout of exchange rate weakness, reflecting the fall in copper prices and increasing worries about Chinese growth.

In Colombia inflation exceed our and market expectations in August. CPI rose 0.48% m/m, while we and the consensus estimated a 0.20% increase. The surprise was driven by the rise in food prices of 0.77%.

In Peru, August inflation was 0.38% m/m, in line with consensus expectations (0.39%). The main driver of the result was food and beverage prices, which increased 0.68% m/m. As a result, accumulated inflation in the first nine months of the year reached 3.4% and y/y inflation has accelerated to 4.0%. Both figures already exceed the top of the target range (2.0%+/-1pp). Given the gradual depreciation of the currency during most of this year, in contrast with most of the region, tradable prices, even if they have accelerated in recent months, have not been a significant source of pressure for Peru, registering an annual increase of 2.75%, significantly below the headline figure. Nonetheless, the growing pressure that the PEN is experiencing, reflecting lower commodity prices, could still push up prices and prevent a moderation of headline inflation in coming months.