Every major economy in South America is missing its inflation target.
Inflation is near a 12-year high in Brazil, at a seven-year high in Colombia, near a four-year high in Peru and has exceeded the target for much of the past two years in Chile. Argentina, which is starting to restore inflation targeting, has price growth of about 30 percent, while Venezuela is in a league of its own with 181 percent inflation last year.
The misses are a sober lesson for central bankers anywhere. Faced with slumping exports as the commodity boom waned, policy makers in Latin America were slow to raise interest rates. Then their currencies slumped against the dollar as the Fed raised its interest rates in December. As policies diverged, exchange rates became powerful channels of inflation in emerging markets.
It's never easy for central bankers to raise interest rates when their economy is on the ropes. Nor can they ignore above-target inflation forever without risking credibility.
Brazilian inflation is expected to average 7.94 percent over the next five years, according to breakeven rates -- the difference between yields on nominal bonds and inflation-linked bonds -- well above the 6.5 percent upper limit of the target range. Meanwhile, Brazil's economy will contract by 3.3 percent this year, according to the median estimate in a Bloomberg survey of economists.
Colombian policy makers have also struggled to convince investors they can keep inflation within their 2 percent to 4 percent target band. Breakevens show traders expect inflation to average 3.94 percent over the next five years, down from a high of 4.65 percent earlier in the year. Chile’s performance on the other hand has been stellar, with five-year inflation expectations rarely departing from the 3 percent target.
To be fair, Brazil has raised its key rate 16 times in three years, but it was fighting against global trends that were beyond its control. The Bloomberg Commodity Index has dropped by more than half over the past six years, showing why receipts by Brazilian exporters tumbled, which undermined the real and pushed up the cost of imports.
Taking a longer-term view puts Brazil’s inflation woes into context. While inflation has exceeded the 4.5 percent target for nearly all of the past decade, it pales into insignificance compared with 25 years ago. The following two graphs on Brazilian inflation become a trick of “now you see it, now you don’t.”
Inflation over the past 26 years.
“The macroeconomic reality today has nothing to do with high inflation episodes that we had in 80s, where we saw total lack of monetary and fiscal control,” said Alberto Ramos, chief Latin America economist for Goldman Sachs Group Inc. in New York. “This is completely different, but it doesn’t mean that we don’t have a bit of an inflation problem. Monetary authorities still have to deal with it.”
Now, inflation may have peaked as economic growth, or the lack of it, comes to the aid of policy makers across Latin America. What's more, a two-year slide in emerging-market currencies is finally petering out, easing pressure on import costs. Brazil's real and Chile's peso have both rallied this year. Policy makers may not have to tighten the screws too much further.