6 Inflationary pressures will ease slightly, thanks to stronger currencies and cyclical weakness

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1 6 Inflationary pressures will ease slightly, thanks to stronger currencies and cyclical weakness Inflation remains within target range in Mexico and Paraguay. It is moderating more clearly in Brazil, Chile and Peru, but not yet in Argentina, Colombia or Uruguay Inflation remains within the target ranges set by the respective monetary authorities in Mexico and Paraguay, in line with the lack of demand pressure, the preventive interest rate hikes announced in the past few months, the impact of reforms on prices in sectors such as telecommunications in the case of Mexico and the reduction in regulated prices (partly due to the effect of lower oil prices on fuel prices) in Paraguay. Even so, in both economies current rates of inflation (2.5% in Mexico and 4.5% in Paraguay) are lower than in previous months (Figure 6.1). In contrast with the situation of Mexico and Paraguay, inflation remains above the target range in all other countries of the region, with the effects of the depreciation of national currencies seen up until the beginning of the year and the pressure on food prices from adverse weather events not being entirely offset by the weakness of internal demand. Added to these regional factors are idiosyncratic factors such as the alignment of regulated prices in Brazil and Uruguay, the fiscal adjustments in Chile and the persistence of inflation (Box 1). Figure 6.1 Inflation: observed and forecast * (YoY %) Argentina (left) Brazil Chile Colombia Mexico Paraguay Peru Uruguay Inflation target Forecast * Left axis: data for Argentina. Right axis: data for all other countries. In any case, in some of the countries in which inflation remains above the target range, there are already clear signs of moderation (Figure 6.1). Specifically, inflation has been slowing for some months now in Brazil, Chile and Peru, having reached 9.3%, 4.2% and 3.9% respectively in April. The recent dynamic of inflation in these three countries has benefited not only from the fading strength of some of the sources of pressure, such as the adjustments to regulated prices in Brazil or to taxes in Chile, but also from the appreciation of their currencies in the past few months. On the other hand in some countries inflation remains above the monetary policy reference ranges and shows no signs of easing. In Colombia, prices rose by 7.9% in April, 3.2 pp more than in April last year, 18 / 34

2 mainly because of the persistent effects of El Niño on food prices. In Argentina, where the inflation rate reached 4.5% in April, recent pressures have come largely from the adjustments to charges for certain regulated public services (water, gas, public transport, etc.) and from the depreciation of the peso following the lifting of exchange controls, although there is evidence that the exchange rate pass-through has diminished (see Box 2), and in spite of the effect s being partly neutralised by the more restrictive monetary policy. Lastly, in Uruguay the inflation rate reached.5% in April, under particular pressure from increases in food prices and regulated prices, and in spite of some progress towards cutting down on wage indexation. All in all, it is possible to assert that in spite of national idiosyncrasies, inflationary pressures have diminished slightly in the past few months, due to stronger currencies and the continuing weakness of internal demand throughout the region. This view is reflected in the recent adjustments to the market s inflationary expectations (Figure 6.2). However, the risk of unanchoring of inflationary expectations remains, mainly in Uruguay, but also to some extent in Brazil and Colombia. Figure 6.2 Changes in the market s inflationary expectations at one year (change in pp since Dec. 15)* BRA CHI COL MEX PER URU * From December 215 to February 216 for Peru, March 216 for Colombia and Mexico and April 216 for Brazil, Chile and Uruguay. Figure 6.3 Inflation: current and market expectations (YoY %) BRA CHI COL MEX PER URU Target range Current inflation 1-year market expectation 2-year market expectation Inflationary pressures will moderate as time goes by Despite the fact that in some cases inflationary pressures have not dissipated in the past few months, currency appreciation, diminished prospects of future depreciation and the weakness of economic activity confirm us in our view that inflation will moderate over the course of 216 and in 217. Indeed these prospects of moderation are also backed up by the vigilant tone of most of the central banks, the fiscal prudence of many countries and economic growth below the potential rate. All the same, the speed of moderation in inflation will depend on the degree of inertia existing in each economy (Box 1). Specifically, we foresee inflation returning to the target range by the end of the first half-year in Chile, by the end of this year in Peru, at the beginning of next year in Brazil and in early 218 in Colombia, while remaining within the target range in Mexico and Paraguay. For Chile, we have reduced our forecasts of inflation for the end of 216 and 217 to 3.2% and 2.5% respectively (.5 pp and.4 pp below the forecasts of three months ago), in the former case largely due to the increased strength of the Chilean peso, and in the latter mainly because of the prospect of a widening output gap. For Peru, recent data have been somewhat lower than expected, in line with the stronger currency and a diminishing effect of El Niño on food production and distribution, so we have revised out 19 / 34

3 forecast for this year's inflation down from 3.2% to 2.9%. For 217, we have adjusted Peru s inflation up slightly, to 2.9% to reflect the slightly greater currency depreciation expected next year. In the case of Brazil, we are leaving unchanged our forecasts of moderation to 6.8% in December 216 and 4.5% in 217, since the latest signs confirm our view that smaller adjustments to regulated prices and the impact of the current recession would eventually create space for the reduction of inflationary pressures. In the case of Colombia, we have adjusted our forecast for this year upwards by.6 pp to 6.2%, largely in view of the impact of El Niño on food prices, and that for 217 by.3 pp to 4.1% due to the persistence of inflation following the price uptick of 216. Inflation will fall in Argentina and Uruguay too (sharply in the former case), although it will continue at relatively high levels (above each country s reference range). In the case of Argentina, the expectation of moderation is based on the view that inflationary pressures lose force as the impact of the exchange adjustment fades and the more restrictive tone of fiscal and monetary policies makes itself felt. Lastly, although inflation could increase slightly in both Mexico and Paraguay, it will, in any case, remain within reasonable bounds, close to the central objectives of 3.% in the case of Mexico and 4.5% in that of Paraguay. More precisely, we foresee inflation of 2.9% this year and 3.3% next in Mexico, practically the same forecasts as three months ago. In this case inflation will increase somewhat next year as economic activity regains its dynamism. As regards Paraguay, we have adjusted the 216 forecast slightly upwards to 4.7% due to food supply factors, keeping the forecast for 217 at 4.5%. 2 / 34

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5 This report has been produced by the Latam Coordination Chief Economist for Latam Coordination Juan Ruiz Latin America Economic Outlook Enestor Dos Santos Argentina Gloria Sorensen Cecilia Posadas Chile Jorge Selaive Lorena Lechuga Colombia Juana Téllez Mexico Carlos Serrano Peru Hugo Perea Venezuela Julio Pineda With the contribution of: Economic Scenarios Julián Cubero US Nathaniel Karp BBVA Research Group Chief Economist Jorge Sicilia Serrano Developed Economies Area Rafael Doménech Emerging Markets Area Financial Systems and Regulation Area Santiago Fernández de Lis Global Areas Spain Miguel Cardoso Europe Miguel Jiménez US Nathaniel Karp Cross-Country Emerging Markets Analysis Alvaro Ortiz Asia Le Xia Mexico Carlos Serrano Turkey Alvaro Ortiz LATAM Coordination Juan Manuel Ruiz Argentina Gloria Sorensen Chile Jorge Selaive Colombia Juana Téllez Peru Hugo Perea Venezuela Julio Pineda Financial Systems Ana Rubio Financial Inclusion David Tuesta Regulation and Public Policy María Abascal Digital Regulation Álvaro Martín Economic Scenarios Julián Cubero Financial Scenarios Sonsoles Castillo Innovation & Processes Oscar de las Peñas Contact details: BBVA Research Azul Street, 4 La Vela Building - 4 and 5 floor 285 Madrid (Spain) Tel.: and Fax: bbvaresearch@bbva.com 34 / 34