The Federal Reserve Building is shown on May 2, 2023 in Washington, DC.Win McNamee (Getty Images)
In its decision this week, and as expected by the market, the US Federal Reserve increased its target interest rate range by 25 basis points.
By announcing this decision, the Federal Reserve also virtually announced the end of its interest rate hike cycle.
In its statement, the Fed indicated that in future decisions it will take into account the accumulated tightening of monetary policy and the lag with which it affects economic activity and inflation.
This was interpreted by the market as a sign that a monetary pause will come from now on.
Of course, the fragility of several midsize regional banks in the United States played a role in this decision and the way they communicated it.
However,
For their part, some Latin American central banks have also ended their bullish cycle or are about to do so.
The central bank of Brazil, for example, made its last interest rate hike in August of last year, when it opted to take it to 13.75%, for which it has already been on pause for eight months.
Chile's central institute made its last adjustment to its target rate in October of last year, when it decided to increase it by 50 basis points and bring it to a level of 11.25%.
In the case of Colombia, the board of the Banco de la República decided this week to increase the interest rate by 25 base points and place it at 13.25%.
Several analysts anticipate that this could also be the last episode of the upward cycle in that country, once inflation finally began to subside in its April data of this year.
Finally,
The Bank of Mexico has also begun to give signs that it could initiate a monetary pause in the decision that it will announce on May 18.
If this occurs, it would imply that his last increase would have been the decision made in February 2023, when he decided to increase his target rate by 25 basis points and take it to a level of 11.25%.
In this context, two relevant questions now arise.
First, does the end of interest rate increases mean the end of monetary tightening?
And second, when will nominal interest rate cuts begin?
To answer the first question, one must understand that the monetary stance is not determined solely by the nominal interest rate, but is also influenced by the level of expected inflation.
This is because what really matters is the ex-ante real interest rate, that is, the difference between the annual nominal interest rate and the expected 12-month inflation.
Thus, if the nominal interest rate remains unchanged, but the expected inflation rate decreases, this will imply that the cost of financing in real terms will continue to increase.
In the case of Mexico, for example, the ex-ante real interest rate at this time is 6.57%, given the difference between the nominal rate (11.25%) and 12-month inflation expectations (4.68%).
So,
Even if Banco de México initiates a monetary pause in its May decision, we may see forward increases in the real interest rate due to the reduction in expected 12-month inflation.
Note that this behavior is highly likely to occur, taking into consideration that the inflation expected by analysts for 2024 is currently 4.1%.
Therefore, as we move forward in the year, it is foreseeable that the expected inflation will begin to converge to a level closer to what is anticipated for 2024 (that is, from 4.68% to 4.10%).
If things don't change significantly, this would imply that the ex-ante real rate could still rise by about 60 basis points in the remainder of the year, even if the nominal interest rate no longer rises.
If this situation occurs,
In summary, the short answer to the first question is that the end of nominal interest rate increases does not necessarily imply the end of monetary tightening.
This may continue for several more months after the pause, if inflation expectations continue to decline.
In the specific case of Mexico, it is very likely that we will see precisely this scenario.
Something similar could happen in the cases of Colombia and the United States, although the magnitudes would be different.
Regarding the second question, the answer will surely vary from country to country.
Reductions are more likely to start earlier in countries that paused earlier.
Thus, in Brazil rate cuts are expected to begin even before the end of the first half of the year, while in Chile rate cuts are already expected starting in July.
In both cases, these decisions would be justified to avoid having extraordinarily high real rates for too long a period, in addition to the fact that inflation in Brazil has already begun to approach its target level.
In the cases of Mexico and the United States, for their part, it is not unlikely that the cuts will begin before the end of the year, although they may do so for different reasons.
In the case of the United States, to respond to its dual mandate and to try to avoid a recession or, where appropriate, seek to make it as shallow as possible without jeopardizing the inflation target.
In the case of Mexico, the reason could be an inflationary level clearly on its way to its objective, which no longer needs to have the highest real interest rates so far this century, which is what would be achieved if it did not reduce nominal interest rates by then.
Subscribe to continue reading
Read without limits
Keep reading
I'm already a subscriber