Rising inflation to be met with unorthodox measures

With the notable exception of Mexico, containing inflation remains the immediate challenge for policymakers in Latin America. Although the pick-up in inflation looks set to be driven by food and energy prices in the near-term, we think that core price pressures will probably build later this year. Faced with sizeable capital inflows, policymakers in most countries are likely to resist further significant appreciation of nominal exchange rates. As such, there is a growing risk that upward pressure on real exchange rates in the region comes through via a rise in asset prices and pick-up in core inflation. The response is likely to utilise a wide range of tools. Interest rates will rise, albeit by less than the market expects. Instead, the monetary policy response will increasingly rely on more ‘unorthodox’ measures such as targeted capital controls, higher bank reserve requirements and even caps on loan growth.