The Central Bank has cut its benchmark interest rate by 0.75 percentage points, less than what the market had anticipated, thus reaching an even 28 percent.
The rate applicable to seven-day loans between banks and the Central Bank had previously been at 28.75 percent and some estimates had envisioned a reduction of up to 26.75 percent (two full points).
Today’s rate cut was on the cards since the government adjusted its inflation targets for the coming years in late December. The revised annual inflation targets were set at 15 percent for 2018, 10 percent for 2019 and, finally, 5 percent for 2020. These targets are a little higher than the ones originally set at the beginning of the Mauricio Macri administration, and were announced after the previous ones had proven unattainable in light of recent data. These new targets have been interpreted by the market as allowing for a relaxation of monetary policy.
The Central Bank mentioned the relaxation of the inflation targets in its rate cut announcement, stressing that in its opinion, the core inflation is nonetheless descending. “Even though the CPI [Consumer Price Index] for December will, as expected, reflect the strong increase in regulated prices, particularly in gas and electricity, and those prices will have a certain impact in the core inflation, the Central Bank’s vision remains that in the last six months, the disinflation process has been consolidated,” stated the Central Bank in a press release. “In this context, a reduction in the benchmark interest avoids an increase in the contractive bias of the monetary policy.”
Promising “caution,” the Central Bank warned that its moderation of the contractive monetary policy can “only be sustainable to the extent that the evolution of disinflation be compatible with the path that is being sought.”
In the run-up to the rate cut and since, the dollar has strengthened against the peso – both this week and at the end of 2017. Dollars were trading hands for 19.34 pesos at the end of trading yesterday, and after a bit of weakening at the start of trading today, the peso won back some of that lost ground and closed at 19.29, ending a stretch of four days in which it had lost value against the dollar.
For Juan Manuel Pazos, Head of Strategy at investment bank and brokerage firm Puente, the peso will likely strengthen against the dollar. Further to questions from BA, Pazos wrote that “Today’s decision will favor ARS positions in two ways. First, we expect the ARS to strengthen to the USDARS18.5 area once the market prices a less aggressive easing cycle. Second, with the prospect of a slower easing, short term ARS instruments will offer a more attractive carry than expected. In our view, we maintain our preference for front-end Lebacs and we find that the move will favor floaters while, at the same time, at the current yields we would start to trim linkers.”
Today’s Central Bank rate cut, the first in 13 months, had been expected by analysts. As such, Balanz Capital’s research team wrote that “as a rule of thumb, there are no significant moves in the Argentine yield curve that are not dictated or manufactured by the BCRA secondary market action. In other words, the Argentine yield curve is Central Bank driven, not market-driven like in Brazil or Turkey. Therefore, we view the recent decline in short dated LEBAC rates from 28.9% to 27.1% to be a clear harbinger of BCRA benchmark rate movements. Moreover, the decline in the long end of the LEBACs curve to 25.6% is an even stronger omen that the BCRA bias has changed (due to political pressure).”
Simply put, Balanz expected the cut to signal “nothing more than a validation of what the LEBAC’s secondary market has already anticipated.” LEBACs (Letras del Banco Central) are short-term debt issued by the Central Bank. Before the 28 percent rate was announced, Balanz noted that “a 27.5% level would reinforce the notion that Sturzenegger (the head of the Central Bank) is back in control of the inflation targeting regime and that the press conference was a stylized reboot based on mutually agreed upon economic realities.”
For Pazos at Puente, the “75 basis points (bp) cut is significantly less than what the market was pricing and below our expected 150bp cut. Before the rate decision, forward rates in the Lebac curve were pricing a 200bp cut in January. The Bloomberg consensus before the meeting was expecting a 125bp cut. In our view, the move shows that the BCRA remains independent from political pressures at the time to decide how to meet the inflation targets.”
Going forward, Puente is “expecting a 300bp cut in 1Q18 (an additional 75bp cut in the second meeting of January, totaling 150bp in the month, 100bp in February and 50bp in March), down from our previous 400bp estimate.” However, by the end of Quarter 2 Puente expects “a context in which we expect inflation to diverge significantly from the path consistent with the revised target, forcing the government to pivot once again towards containing inflation.”