Sticky Inflation Fuels Rate-Hike Pressure in Brazil and Mexico

Latin America’s top central banks are coming under growing pressure to raise interest rates, as inflation stands way above the target ceiling in Brazil and Mexico.

Consumer prices in both countries came in above forecasts in May, showing persistent inflationary shocks even as central bankers expect them to be transitory. Inflation in Brazil was driven up by electricity prices, while in Mexico food and services were the main culprits.

The data came ahead of interest rate decisions in both countries. Brazil’s central bank is expected to lift interest rates by 75 basis points next week, its third consecutive hike of that magnitude this year. Mexico’s central bank, known as Banxico, will revisit later this month its decision to hold the benchmark rate at a near five-year low of 4%.

Sticky Inflation Fuels Rate-Hike Pressure in Brazil and Mexico

Consumer prices in Brazil jumped 8.06% in May from a year earlier, more than double the 3.75% target for 2021. Swap rates rose, with contracts maturing in January 2022 up 5 basis points, as traders bet the central bank will have to raise borrowing costs more aggressively.

In Mexico, annual inflation slowed slightly to 5.89%, still way above the 3% goal. The peso fell slightly after the data was released, then pared losses.

Brazil’s Drought

A severe drought that threatens Brazil’s ability to produce cheaper hydroelectricity is pushing up energy prices in the country, adding to higher commodity prices.

“Truth be told, when you look at the numbers, those temporary pressures are lasting longer than expected,” said David Beker, head of Brazil Economics at Bank of America Securities Inc. He revised up his forecast for year-end inflation to 5.9% from 5.2%, saying most of the pressure will come from government-regulated prices.

As the Brazilian economy shows signs of a stronger-than-expected rebound, focus has turned to prices in the services sector.

“The central bank will need to be careful about how the reopening impacts services,” said Cassiana Fernandez, economist at JPMorgan Chase & Co. “Core inflation was higher than we anticipated and there are upside risks to this year’s inflation threatening to contaminate next year’s expectations.”

What Bloomberg Economics Says

“The combination of high headline and uncomfortable core inflation corroborates the centrla bank’s decision to reduce monetary stimulus, but low service inflation and high unemployment are obstacles for a full normalization -- a rise to the neutral policy level, estimated to be 6% to 7% -- at this time.”

--Adriana Dupita, Brazil economist

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Central bank chief Roberto Campos Neto said on Tuesday that prices in the services sector will be discussed next week as part of the interest rate decision. In previous meetings, central bankers have said some level of stimulus is still needed. Traders are pricing in at least a 75-basis-point lift, and additional hikes taking the Selic to 6.5% by the end of the year.

Mexico’s Core Inflation

Mexico’s central bank is under increasing pressure to hike rates at some point this year, as inflation again came in above expectations and far above the 4% target ceiling -- even as base-effect pressures dissipate.

Economists are particularly worried because core inflation, which excludes volatile prices such as fuel and is closely watched by policy makers, is also on the rise. It climbed 0.53% in May compared with the previous month, above a 0.48% median forecast from economists.

“This first print in which base effects are beginning to fade away is not a good one,” said Jessica Roldan, chief economist at Finamex.

What Bloomberg Economics Says

“Inflation through May points to mounting pressure on prices from a number of supply and demand shocks. These may be transitory but risk having second round effects and contaminating inflation expectations. They increase the probability for monetary tightening.”

--Felipe Hernandez, Latin America economist

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Core inflation will need to moderate in July and August to give Mexican policy makers some breathing room, according to Marco Oviedo, chief Latin America economist at Barclays.

“Otherwise, once again, it will fail to meet Banxico forecasts and the board might act with hikes sooner than expected,” Oviedo said, forecasting monetary tightening to begin in November.

Inflation is accelerating in most of Latin America. In Colombia, it jumped the most in more than two decades as civil unrest hit supply chains that were already strained by coronavirus lockdown restrictions. In Chile, it sped further above target due to higher commodity costs, leading policy makers to signal they could raise interest rates soon. In Peru, it was above all economists’ expectations.

©2021 Bloomberg L.P.

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