Bloomberg Línea — The war in Ukraine and rising commodity prices have contributed to negative surprises in Latin America’s inflation data for the first quarter of 2022.
The worsening of the panorama has led to increased inflation projections in the region, with the market estimating a peak in the second quarter of 2022, followed by a slow convergence to the target. At least that is the assessment of Brazilian investment firm XP (XP).
In a report released this week and obtained exclusively by Bloomberg Línea, XP economists Caio Megale, Andres Pardo and Francisco Nobre draw attention to the shocks in global supply chains caused by the pandemic, as well as the increase in commodity prices intensified by Russia’s invasion of Ukraine.
Even though central banks in the region have been aggressive in raising interest rates, in some cases, such as the increase in food prices, whose inflationary pressure comes from supply, there is little that monetary authorities can do to help reduce prices, and therefore the expectation is for higher inflation and for longer, according to the XP report.
Here are XP’s projections and estimates for inflation and interest rates in Brazil, Colombia, Mexico and Chile:
Brazil: Inflation Above Target for the Next 2 Years
In Brazil, inflation has been consistently surpassing estimates since mid-2021, reaching a 12-month high of 11.3% in March. And according to XP’s evaluation, the price index will remain above target during the next two years.
XP expects inflation to peak in April, reaching a high of 11.8% year-on-year, and ending 2022 at 7.4%.
“This figure takes into account the impact of the war in Ukraine, and the ongoing supply chain disruptions on inflation. Against this volatile and uncertain backdrop, risks are tilted to the upside,” the team writes.
In 2023, inflation is expected to end the year at 4% and return to the 3% target by 2024. In this context, XP sees a more aggressive central bank and estimates increases in the Selic rate until it reaches the end of its high cycle, with a rate of 13.75% in mid-2022.
The central bank’s monetary policy committee will meet in the first week of May to decide the direction of the basic interest rate in the country. The expectation, according to the bank’s most recent Focus report, is for a one-percentage-point increase, taking the Selic to 12.75% per year.
Colombia: Inflation Fueled By Food Prices
In Colombia, inflation maintained an upward trend above expectations in the first two months of 2022, with a 12-month high of 6.94% in January and 8.01% in February, against projections of 6.39% and 7.62%, respectively.
During that period, the largest contributions to inflation were food prices, impacted by the rise in commodity prices, shock in the supply chain and the drop in food supply due to heavy rains in the region.
XP expects inflation in Colombia to peak at around 9% over 12 months in April, and then start to decline, falling to 7.3% year-on-year by the end of 2022.
In light of recent price pressures, that forecast has been revised upward significantly from the 4.1% year-over-year high expected at the end of last year.
As for 2023, economists expect inflation to fall to 4.1% year on year.
Regarding monetary policy, XP’s expectation is that the Colombian central bank will continue to raise interest rates in the same magnitude in its next meetings until it reaches the terminal rate of 8% in third quarter, and remaining constant until the end of 2022.
“Due to inflationary surprises and a more hawkish tone from the central bank, our current projection is substantially higher than the 5.25% basic interest rate we expected at the end of last year,” the economists led by Caio Megale state in the report.
Mexico: Energy Prices Cooling
Despite the moderate increase in inflation in Mexico in first quarter, XP states in its report that the diffusion index averaged 82.2 points, above the historical average of around 65 points, indicating that inflationary pressure remains widespread, with few signs of relief.
XP’s economists recall that since 2021 the government has increased the IEPS fuel tax subsidy as a mechanism to soften price increases. Consequently, energy inflation has declined significantly from its peak of 28% year-on-year in April 2021 to 5.23% in March 2022.
In XP’s view, inflation has already peaked in Mexico and should remain moderate, close to current levels, in the coming months, and projects an inflation rate of 7% by the end of 2022, cooling down to 4.2% by December 2023.
On the monetary policy side, Megale’s team has revised the interest rate projection upward a few times this year and now expects Mexico’s central bak to raise interest rates to 8.5% by the end of 2022 and to the terminal rate of 9% by the first quarter of 2023.
Chile: Cost-and-Demand Inflation
As in the other South American countries, inflation in Chile was mainly driven by the increase in food prices in the last two months of the quarter, which added 0.49 percentage points and 0.93 percentage points to the price index in February and March respectively.
In the report, XP writes that the overall increase in core inflation in first quarter resulted from currency weakness, higher prices of imports, supply disruptions, and indexing to past inflation, mainly in educational services.
Still, pressures were also driven by demand in Chile, due to excess household spending on account of the massive liquidity injections to consumers with tax relief and pension withdrawals last year.
“We believe that supply and demand-side price pressures are still present in Chile, and that inflation will continue to rise through mid-year, peaking at around 10% year on year. Currently, we expect year-on-year inflation to end the year at 7.7%, and which we have significantly revised since the end of last year, when we were projecting 3.7% year on year,” the XP report states.
According to the firm’s economists, the Chilean central bank should reach the terminal rate at around 8.50%, with upside risk of 9.50%.
“Given the recent surprises in inflation, it may be challenging to slow the pace of tightening considerably from the most recent 1.5% hike, while we continue to see limited room for interest rate cuts until the end of the year.”
Translated from the Portuguese by Adam Critchley