Since the start of the month, markets have swung from expecting hikes to pricing in policy loosening in Brazil, Chile and Mexico, where the central bank stunned markets on Friday by opening the door to rate cuts.
The region’s policymakers were among the most aggressive in tightening policy after the global financial crisis. They may now be among the first to start easing, following in the footsteps of Denmark, Turkey and Switzerland.
Economists said policy overall in the region was looser than it was in mid-2008, meaning cuts would likely be more gradual than in the last round of easing.
“I would say that based on the deterioration of external conditions, the tightening cycle in Latin America is basically done,” said Alfredo Coutino, Latin America director for Moody’s Analytics.
“The probability of a new external shock in the coming months has increased ... we might see interest rate cuts in coming months, central banks are going to be cautious and go slow.”
Central banks in the region’s export-oriented economies will be closely watching conditions in Europe and the United States and the evolution of commodity prices, a major source of income for many as well as a source of inflation pressures.
Commodity prices, as tracked on the Reuters/Jeffries CRB index, fell more than 7 percent in eight days at the start of August, when financial markets were rocked by fears of a new global collapse. They have since made up some ground.
HSBC economists said Colombia and Peru could both cut rates if raw material prices plunged in a bid to protect their economies from negative wealth effects.
Lower rates may help to ease painful currency appreciation by removing part of the region’s attractiveness in the eyes of foreign investors, who have pumped in capital to take advantage of higher returns.
Economists estimate a 10 percent fall in the CRB index in terms of the Brazilian real would cut 0.5 percent from inflation in Latin America’s biggest economy, which is well above the central bank’s ceiling at around 7 percent. Other countries in the region have inflation rates of between 2.9 and 3.5 percent, below 2008 levels.
Until recently, investors expected Brazil to raise rates or hold them at the current 12.5 percent, the highest of any large economy, into 2012. But the country’s interest rate futures and economists’ estimates now show a cut before the end of the year. The central bank is expected to keep rates unchanged next Wednesday, its first pause this year.
Overnight interbank interest rate futures contracts for Dec. 30 settlement, which show rate expectations for the end of 2011, slipped below 12 percent on Friday from 12.475 percent at the start of the month, the lowest this year.
“This is new,” said Zeina Latif, Latin America economist with RBS Securities in Sao Paulo. “Until recently the market had only been pricing in a cut next year.”
In Chile, which has tightened policy the most in the last 12 months, interest rate swaps point to a 25 basis point rate cut in October from the current 5.25 percent, with rates seen around 4.5 percent at the end of 2012.
Chile Central Bank President Jose De Gregorio says a rate cut is now just as likely as a hike, although rates could also be held for several months.
The Banco de Mexico, which analysts had seen as less likely to cut than its peers, said it would consider lowering rates if the economy and market moves brought about an unintentional tightening in monetary conditions.
Markets jumped to price in a 25 basis point cut as early as January — a turnaround from the start of the month, when investors had been betting on a hike by mid-2012.
A key difference compared to the last easing cycle is that cuts begin from a lower starting point, with rates standing at an average 6.25 percent in Brazil, Mexico, Chile, Colombia and Peru, compared to 9.33 percent three years ago.
This means that central banks cannot provide the same degree of stimulus as they did following the crisis, when average rates in the region more than halved, and may act more cautiously in the size and timing of cuts.
“Central banks will be ready to cut, if they need to, regardless of the fact that they have now looser monetary conditions than in 2008,” said HSBC economist Andre Loes. “If the slowdown in the developed markets proves very intense, the conditions for easing monetary policy will materialize and rates will be shaved.”
