Central Bank Review: A Catch-Up Hike

Research evidence excerpt

Central Bank Review: A Catch-Up Hike

IdeaMunderlying persistence of inflation than on the recent improvement in financial

market pricing, viewing the decline in breakeven inflation as insufficient evidence

that inflation has become durably anchored.

The Board's assessment of the economy remains broadly constructive. GDP growth

accelerated to 2.2% y-o-y in the first quarter, with domestic demand continuing to

expand faster than output, while the labor market remains exceptionally tight, with

unemployment falling to 8.0% and wages continuing to register strong increases. At

the same time, BanRep maintained a cautious assessment of the external

environment, highlighting ongoing risks associated with Middle East tensions

through higher fuel and fertilizer prices, as well as uncertainty surrounding global

monetary policy. Taken together, these developments reinforce the view that upside

risks to inflation continue to dominate.

Looking ahead, we continue to expect BanRep to deliver two additional 25bp hikes,

taking the policy rate to a terminal level of 12.50%. While the election outcome has

reduced political uncertainty and increased the likelihood of a more orthodox

macroeconomic policy mix, inflation remains well above target and underlying

pressures continue to build. We therefore believe further monetary tightening will

be required to ensure inflation returns to a sustained downward path. That said, the

divided vote suggests the pace of tightening beyond June is far from predetermined.

Strategy: Going into the meeting, market pricing incorporated ~60bp of hiking

premium for June and a total of ~120bp of hikes (implied terminal ~12.50%). In line

with our preview, we think to the extent that 24-months CPI expectations return