As the Covid-19 crisis fades, what’s in store for monetary policy in Latin America?

    The Central Bank has lowered the LELIQ rate substantially over the last year, while it has continued to finance the government’s fiscal deficit in response to market aversion. The Bank has also tightened currency controls in a bid to prop up the ailing peso amid talks with the IMF over a fresh bailout package.

    Looking ahead, we are not optimistic about prospects: Inflation is set to stay well in double digits and the peso will continue to crumble amid huge increases in the money supply.

    • Argentina

    The Central Bank has lowered the LELIQ rate substantially over the last year, while it has continued to finance the government’s fiscal deficit in response to market aversion. The Bank has also tightened currency controls in a bid to prop up the ailing peso amid talks with the IMF over a fresh bailout package.

    Looking ahead, we are not optimistic about prospects: Inflation is set to stay well in double digits and the peso will continue to crumble amid huge increases in the money supply.

    • Bolivia

    2020 in Bolivia was characterized by not only the global pandemic, but also by elevated social and political instability. With general elections delayed three times during the year, Luis Arce and the MAS (Movement for Socialism) party finally regained the presidency after Evo Morales’ deposition in late 2019. This paved the way for a continuation of the Central Bank’s expansive policies in order to support the economy during 2020, most notably through liquidity injections and the continued exchange rate management, which has kept inflation well in check.

    The Bank should maintain its accommodative stance going forward, as the economy begins to show signs of recovering from last year’s downturn. While inflation should end the year at a lower level than the majority of regional peers—giving the Bank space to remain dovish—the continued drawdown in international reserves is a cause for concern, potentially risking the stability of the exchange rate going forward.

    • Brazil

    During 2020, the Central Bank of Brazil continued the monetary policy easing cycle that it began in mid-2019, extending the sequence to nine consecutive rate cuts and thus pushing the benchmark SELIC interest rate to a record low of 2.00% in August. Concurrently, the Bank engaged in various measures to inject liquidity into the financial system—including reduced reserve requirements, loan provisions and eased lending rules to SMEs—which dovetailed with the government’s substantial fiscal stimulus that totaled around 12% of GDP.

    While the economic recovery seemingly lost momentum in the first half of 2021 amid still-elevated daily Covid-19 cases and ongoing restrictions on daily life, the Bank’s liquidity provisions proved to be temporary, with the majority of support measures withdrawn since the start of the year. Moreover, spiraling inflation in recent months has prompted the Central Bank to act drastically, increasing the SELIC rate by 325 basis points since the beginning of the year, with further hikes being penciled in before year-end.

    • Chile

    The Central Bank took an axe to its policy rate last year, reducing it to the lowest level since 2009. Moreover, it introduced a new funding facility for banks and began purchasing bank bonds. Bank bond purchases were also designed to support pension fund providers in the wake of successive government-mandated drawdowns from private pensions. The measures have helped stabilize the financial system and avoid negative fallout from the pension withdrawals.

    With the economy currently riding a wave of fiscal stimulus and price pressures picking up, we expect the Central Bank to dial back its monetary stimulus going forward: Our Consensus sees rates rising slightly over 50 basis points by the end of this year.

    • Colombia

    The Central Bank of Colombia entered a new monetary easing cycle after the pandemic hit last year in a bid to support the stricken economy, slashing the benchmark interest rate by 250 basis points during March–September. The Bank also announced several liquidity measures in both pesos and USD throughout the year: It purchased public and private debt instruments, reduced reserve requirements, reinforced intervention in the public debt market, introduced new FX swap auctions and established an auction of non-deliverable forwards. The Bank’s actions and the government’s accommodative fiscal stance helped to push the economy above pre-pandemic levels in Q1 2021.

    Widespread protests from the end of April have since hampered activity, but leading indicators suggest underlying momentum remained strong into the second quarter nonetheless. Meanwhile, building price pressures have sparked concerns of sticky inflation ahead, and at its latest meeting on 30 July the Bank noted that the policy space to maintain its accommodative stance was narrowing. This increases the likelihood of rate hikes by year-end.

    • Costa Rica

    Last year, the Central Bank of Costa Rica (CBCR) opted to slash its policy rate to an all-time low of 0.75% and ease debt burdens on borrowers in a bid to mitigate the impact of the Covid-19 health crisis. Thereafter, the Bank has been on hold for 14 consecutive months in order to buttress activity amid subdued price pressures. The continued accommodative stance, combined with liquidity injections in the form of quantitative easing and preferential interest rate loans to affected firms, has helped to accelerate the economic recovery—with indicators for Q2 2021 hinting at improving conditions.

    Going forward, a still-fragile recovery, coupled with a persistent output gap, will likely prompt the CBCR to maintain its accommodative stance in the final stretch of 2021. Moreover, although inflation has picked up recently, the Bank has attributed the increase to a low base effect and transitory factors. That said, we expect the Bank to tighten in 2022 as the economy gains strength.

    •  Dominican Republic

    Since the Covid-19 outbreak began, the Central Bank of the Dominican Republic has cut rates by 150 basis points and injected close to USD 4 billion of liquidity to support the economy. The Bank’s measures, together with fiscal support from the government, have helped steady the ship: Private-sector credit is expanding sharply and the economy is now back above its pre-pandemic level, making the Dominican Republic one of the region’s star performers.

    This strong showing should allow the Bank to begin phasing out some stimulus going forward, with rates expected to rise this year and next. Recent high inflation is a risk though: If it leads to a de-anchoring of inflation expectations, this could force the Bank to tighten quicker than it would like, throwing a spanner in the works for the economic recovery.

    • El Salvador

    U.S. dollars are legal tender in El Salvador, and thus the country’s monetary policy is tied to that of the United States. Consequently, the policy stance has been extremely accommodative since March 2020. That said, additional measures were taken domestically in a bid to support the economy after the outbreak of the Covid-19 pandemic, such as lower reserve requirements, a trust fund to support workers and relaxed lending conditions. Moreover, the government provided fiscal stimulus to further support activity.

    The economy is projected to rebound this year from 2020’s downturn. The recovery seems to be underway as GDP returned to growth in Q1, and data for the first two months of Q2 shows activity picked up further. The use of USD means that inflation is set to remain well anchored this year.

    • Guatemala

    The Bank of Guatemala (Banguat) cut the key interest rate twice in March last year to a then all-time low of 2.00%, in response to the outbreak of the pandemic. It also eased certain credit regulations to help businesses and households meet their debt obligations. On 24 June, Banguat lowered the key interest rate to a new all-time low of 1.75% as the impact of Covid-19 became more pronounced—the economy tumbled nearly 10.0% in Q2 2020. The Bank’s actions and the government’s fiscal response have been fairly successful over the last year, with GDP rising above its pre-pandemic level in Q4 2020.

    The economy’s strong performance amid a notable firming of domestic demand, coupled with potentially higher price pressures, could give the Bank reason to tighten its monetary policy stance ahead. However, premature tightening could derail the still-fragile recovery. Given the tightrope Banguat is walking, the majority of our analysts expect it to take a wait-and-see approach and hold rates steady for the rest of this year.

    •  Honduras

    In response to the outbreak of the unprecedented global health crisis in March and the landfall of two hurricanes in November, the Central Bank of Honduras (BCH) slashed the policy interest rate by a cumulative 225 basis points on three occasions last year to a new all-time low of 3.00%. The BCH also suspended liquidity absorption operations until October 2020, reduced reserve requirements, and temporarily brought back mandatory investments of 3% in a bid to rekindle credit growth. The Bank’s response, coupled with the government’s small albeit well-targeted fiscal stimulus package, has been somewhat successful as the economy managed to return to growth in Q1 2021.

    Looking ahead, the BCH will likely maintain an accommodative stance as underlying momentum remains frail. The key risk is uncertainty over the nature of inflation, and whether higher price pressures will be transitory or permanent. Our analysts see inflation continuing to rise through next year, although if the Bank tightens its monetary policy stance prematurely it risks throwing a spanner in the works for the economic recovery.

    •  Mexico

    The Central Bank cut its policy rate after the beginning of the Covid-19 crisis—although it remained elevated by regional standards—and expanded its liquidity facilities. However, the government’s restrictive fiscal stance left the Bank high and dry, leading to one of the largest economic contractions in the region in the last year.

    Banxico’s attention has now turned to breaking the back of inflation which has surged so far this year, and following a 25 basis-point hike in June we expect two or three more rate hikes of the same magnitude by year-end.

    •  Nicaragua

    Nicaragua has a crawling peg against the USD, which keeps inflation expectations well anchored but puts limitations on the flexibility of monetary policy. Still, the Central Bank of Nicaragua cut its repo reference rate by a total of 325 basis points to 3.50% between March 2020 and March 2021, alongside other measures to cushion the fallout from the health crisis and from hurricanes Eta and Iota in November 2020.

    As a result, the economy’s performance has improved overall since the downturn bottomed out in Q2 2020. GDP bounced back to growth in Q1 2021, while high-frequency data shows momentum accelerated in April–May. Additionally, a tighter labor market and extensive fiscal stimulus in the U.S. have bolstered remittance inflows, buttressing spending in turn. However, the recovery is still fragile and data is flattered by a low base effect, so the Bank will likely continue its accommodative stance in the short term.

    • Peru

    Across March–April 2020, the Central Bank of Peru cut rates by a combined 200 basis points, in response to one of the worst Covid-19 outbreaks and some of the most stringent lockdown measures in the region. Since then, the Bank has steadfastly stuck to the all-time low rate of 0.25% for 15 subsequent months, while also delivering nearly PEN 65 billion (around USD 16 billion) in targeted liquidity measures that have seen lending rates fall considerably.

    Even though signs of an economic rebound are emerging—activity is now only slightly below pre-pandemic levels—the Bank has sustained rates at their record low level and has continued to push liquidity into the economy. However, spiking inflation in recent months, driven by rapidly rising food prices and a sharp depreciation of the sol amid investor concerns over the new Castillo administration, has prompted the Bank to moderate its dovish tone, with a rate rise before year-end potentially on the cards.

    • Uruguay

    Up until 3 September 2020, the Central Bank of Uruguay used targets of money supply growth and inflation to conduct monetary policy. It then changed from monetary aggregates to a monetary policy rate to anchor inflation expectations. The rate, initially set at 4.50%, was largely in line with the prevailing overnight interest rate level, and thus the Bank maintained an expansionary stance that aimed to support the economy in the wake of the Covid-19 pandemic.

    Since then, the Bank has kept the rate unchanged in a bid to continue supporting the recovery and to ensure there is enough liquidity in the system. However, it also stated it would start a gradual tightening process once the recovery firms, which is expected sometime in H2 this year.

    •  Venezuela

    During 2020, the Central Bank of Venezuela continued to battle the twin evils of rampant inflation and unrelenting currency depreciation, as it has done for a number of years since the country descended into a spiral of economic degradation in the early 2010s. While the increasing dollarization of the economy has helped stem price pressures somewhat, the Bank’s continued practice of printing money to finance the fiscal deficit ensured that annual inflation remained at four-figure levels throughout 2020.

    Echoing a similar move made in August 2018, the Central Bank has floated the idea of cutting six zeroes from the beleaguered bolívar, in an attempt to calm the ravages of hyperinflation. Moreover, a seemingly improving economic outlook amid steadily rising oil output should offer some support to government finances. However, with the Biden administration appearing in no rush to loosen the vice-like grip of the Trump-era “maximum pressure” campaign of sanctions, elevated inflation and incessant currency depreciation are set to remain a feature of Venezuelan life going forward.


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