The first half of 2024 has seen significant economic developments in Latin America, characterized by a cycle of monetary easing, gradual inflation decline, and steady economic growth. This period has been marked by diverse financial conditions, varying responses to global economic shifts, and a persistent focus on managing inflation and fostering sustainable growth. Here are ten key insights into the current economic landscape of Latin America, from the report by Banco de España:
Latin American central banks initiated a cycle of monetary easing in the second half of 2023, driven by a need to support economic activity as inflation began to show signs of easing. The pace and scale of interest rate cuts have varied significantly across the region, reflecting different economic conditions. For instance, Chile has been more aggressive, with rate cuts amounting to 550 basis points, while Mexico has taken a more cautious approach with 25 basis point reductions. This divergence is due to varying inflationary pressures, fiscal policies, and the stage of the business cycle in each country.
Inflation across Latin America has been on a downward trajectory in the first half of 2024, largely due to the easing of core inflation. However, services inflation remains persistently high, particularly in Colombia, where it is slowing the overall decline in inflation. The gradual disinflation process is expected to continue, with inflation likely to fall within central banks' target ranges in the coming quarters. However, the stickiness of services inflation poses a challenge, indicating that the disinflation process might be slower than anticipated.
Financial markets in the region have adjusted their expectations for further rate cuts, with limited reductions expected in countries like Brazil, Chile, and Peru, where the easing cycle began earlier. There is more room for cuts in Colombia and Mexico, although these are expected to be modest. The trajectory of inflation will be the key determinant of future rate cuts, influenced by economic activity, volatile items in the consumption basket, inflation expectations, and US monetary policy decisions.
Latin American economies are forecasted to grow at rates close to their potential in 2024 and 2025. This outlook represents a slight slowdown for Brazil and Mexico compared to 2023, while countries like Chile, Colombia, and Peru are expected to see improved growth following recovery from economic challenges. Key drivers of this growth include resilient labor markets, monetary easing, rising commodity prices for certain producer countries, and reduced economic policy uncertainty in some areas. However, external risks, such as tighter-than-expected US monetary policy and a sharper-than-expected slowdown in China, could pose challenges.
Financial conditions, which had been easing since late 2023, started to tighten again in March 2024, despite ongoing rate cuts and some exchange rate depreciation. This tightening is attributed to the increased cost of public debt in Latin America, driven by deteriorating public finances in some countries, lower profitability of carry trades, and specific national dynamics such as post-election developments in Mexico. The shift in financial conditions underscores the region's vulnerability to global financial market changes and domestic fiscal challenges.
The onset of monetary easing has led to a modest increase in lending activity, which is expected to gain further momentum in the coming quarters. However, the banking sector still faces challenges, with non-performing loans remaining high by historical standards. While risks to the banking systems are currently contained, the uneven pass-through of policy rate changes to bank lending rates across different countries and segments indicates underlying vulnerabilities in the financial sector.
Fiscal policy in the region appears to be looser in 2024, which may slow the pace of monetary easing. The report highlights concerns about public debt sustainability, particularly in Brazil and Mexico. The Banco de España's new sustainability analysis tool underscores the importance of managing public finances carefully to avoid exacerbating vulnerabilities. The fiscal outlook in these countries will be crucial in determining the trajectory of future monetary policy decisions.
Services inflation in Latin America has proven particularly persistent, especially in Colombia and Mexico. This persistence is attributed to both "inherited" and "intrinsic" factors—either the cumulative impact of previous inflationary shocks or the increased sensitivity of inflation to new shocks. The Colombian central bank has noted that high inflation might lead to changes in the economy's degree of indexation, making it crucial to continue studying inflation stickiness and its drivers to better manage monetary policy.
The region's currencies have depreciated against the US dollar in the first half of 2024, largely due to the narrowing of policy rate differentials with the United States. This depreciation has been more pronounced in countries like Chile and Brazil, which have implemented larger rate cuts. However, the impact of this depreciation has been mitigated by rising commodity prices, particularly in energy and metals, which are key exports for several Latin American economies. The interplay between domestic monetary policy and global commodity markets will continue to be a significant factor in exchange rate movements.
Despite the recent inflationary pressures, long-term inflation expectations in Latin America have remained anchored, a testament to the credibility of the region's central banks. However, there has been some upward pressure on expectations, particularly in Brazil, where fiscal policy concerns may be influencing inflation expectations. Maintaining this credibility will be essential as central banks navigate the challenges of balancing inflation control with supporting economic growth.
