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Mexico has become the last major Latin American country to cut interest rates, easing its restrictive policy with inflation well below its peak and putting the region at the forefront of the global easing cycle.
The decision by the Bank of Mexico on Thursday to cut rates by 25 basis points to 11 per cent comes as most central banks in developed countries have yet to loosen monetary policy.
Latin American central bankers’ swift response to soaring inflation after the coronavirus pandemic has transformed their credibility as they emerge from the most serious wave of price pressures in decades.
Their counterparts in advanced economies, meanwhile, were criticised for holding on for too long to the notion that the burst of inflation that followed the initial stages of the pandemic would prove shortlived.
Brazil and Mexico raised rates in the first half of 2021, while Chile, Colombia and Peru followed later that year. The US Federal Reserve and the European Central Bank did not raise rates until 2022.
Latin American central banks had been playing catch-up with advanced economies, trying to follow their lead in becoming less politicised, inflation-targeting institutions with flexible exchange rates.
With central bankers’ independence now enshrined, the region’s brushes with hyperinflation made them more attuned to the risks of delay, analysts said. It also meant rates reached far higher levels than in advanced economies, giving them a cushion to begin cutting earlier after sharp drops in inflation and a slowdown in growth.
Although the region’s main inflation-targeting central banks are now easing monetary policy, persistent inflation risks could make their easing path rocky, analysts said.
“Further rate cuts are going to be a bit more gradual,” said Jason Tuvey, an emerging markets economist at Capital Economics. “The last mile of monetary policy easing . . . [is] going to be a lot more difficult.”
Brazil’s central bank cautioned on Wednesday that various measures of underlying inflation remained above target, as it cut rates for the sixth time in a row to 10.75 per cent from 13.75 per cent in August.
Colombia has cut rates twice but has seen slow growth and inflation well above target. Inflation in Chile has been slashed, but traders say the central bank’s erratic rate cutting schedule — with the size of cuts varying at each meeting — has worsened the volatility of the peso.
Mexico’s economy, the second largest in Latin America, has been relatively resilient, with growth of 3.3 per cent last year and unemployment at historic lows. But service inflation has remained higher than expected, and Jonathan Heath, a member of the central bank’s board, cautioned the market should not necessarily expect another cut in May.
“We see this is a kind of fine tuning . . . simply so monetary policy doesn’t become too restrictive,” Heath told the Financial Times after the decision on Thursday. “If we make some cuts before the end of the year, they wont necessarily be continuous cuts, we will remain very prudent.”
Latin America’s central banks began cutting earlier than the rest of the world in part because their rates were already at a much higher level, but their experience balancing the ongoing risks of inflation with easing monetary policy will be closely watched.
Big central banks are planning rate cuts this year, with goods inflation well down from its peak in many economies, though stickier services inflation has given some economists cause for concern.
Some analysts have argued that advanced economies are experiencing an “immaculate disinflation” as the economy and labour market remained strong despite higher rates that have helped inflation come down. But Federal chair Jay Powell said on Wednesday that the road to 2 per cent inflation was “bumpy”.
The Swiss National Bank unexpectedly cut rates on Thursday, making it the first central bank of a major western industrialised country to do so in the current cycle, but the Fed and the ECB are not expected to take action until later this year.
Most analysts expect interest rates in Latin America to remain restrictive, but given uncertainty about when the Fed will cut rates — affecting investors’ appetite for riskier emerging market assets — and domestic inflation, central bankers will need to try to be flexible without looking volatile, they said.
Despite their autonomy from governments and floating exchange rates, the region’s central banks have still had to deal with attempted political interference.
Central bank governors in Brazil and Colombia have come under pressure from President Luiz Inácio Lula da Silva and President Gustavo Petro, respectively, to cut rates further to help boost the economy. They have resisted.
In Mexico, President Andrés Manuel López Obrador has been criticised for nominating central bank board members seen as close to him, including its first female governor, Victoria Rodríguez. But the president has shown limited interest in monetary policy, and high rates have strengthened the peso significantly — something López Obrador touts on the campaign trail as a sign of economic success.
Alejandro Werner, director at the Georgetown Americas Institute, said he hoped that central banks in the region would in future be able to behave more like those in advanced economies and avoid interest rates reaching such high absolute levels.
“I think gradually . . . central banks in Latin America should internalise the credibility and reputation gained in the global financial crisis [and] in the Covid cycle,” Werner said. “Some of them will be able to act a little bit less aggressively in future inflationary bouts.”
Additional reporting by Claire Jones in Washington, Joe Daniels in Bogotá and Ciara Nugent in Buenos Aires
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