Fynsa
After a series of interest rate hikes, each more aggressive than the last, accompanied by false expectations that the pace of increases would finally slow down and a host of other surprises in that regard, the Central Bank appears to have put this cycle of continuous increases—which began in the middle of last year—on hold. Thus, the rate rose from 0.5% to 11.25%, that is, from an extremely expansionary monetary policy to probably the most contractionary one we have seen since the return to democracy.
Undoubtedly, the question that immediately comes to mind is why he decided to bring the process to a close at this point. With the publication of the minutes from that meeting, we can delve a little deeper into the reasons behind this decision.
First, although monthly inflation remained high and year-over-year figures had exceeded the projections in the latest IPoM, it is also true that these figures were beginning to decline and the outlook for the most volatile components did not, for the time being, appear to show the increases seen in previous months. In fact, in some cases, these prices were beginning to show declines, particularly in the case of certain food items. Additionally, certain cost indicators, such as ocean freight rates or even the exchange rate, continued to fall; or, in the case of the exchange rate, it was no longer influenced by domestic weakness, but rather by the global strength of the dollar, which resulted in very different price pass-throughs.
Second, despite the recent improvement in the services sector, overall economic activity continued to show weakness, a trend that is expected to continue going forward. Sectoral indicators confirmed this view, which was consistent with the decline in private-sector forecasts. The global economy, meanwhile, also showed signs of weakness, against a backdrop of high inflation, reduced support from monetary policy, and significant geopolitical risks.
Third, the financial sector also confirmed this slowdown in growth, with declines in credit indicators, greater difficulty in accessing credit, rising market rates, and falling stock prices. Despite the skeptics, the economy is indeed making the adjustment in line with the Central Bank’s objectives, which, sooner or later, will have an impact on inflation.
This idea that tight monetary policy reduces prices—though it may seem somewhat obvious—is what has underpinned our view that inflation will be lower than the market expects over horizons longer than one year and, consequently, that the average price level will be lower than that implied by financial assets for that same horizon. With that in mind, the Council decided to put an end to the monetary tightening (or, at least, to pause it based on the information available so far), and the important question that arises is: for how long? Will it be a short pause, with a cycle of rate cuts beginning in early 2023, or a somewhat longer one that will require data on its scope for at least two more quarters?
Our view leans toward the second option, since if the indicators begin to show unequivocally that prices have started to normalize, we could opt for more aggressive adjustments rather than risk starting too early and then having to backtrack. The important thing is that, right now, we need to focus on the next question.
