Latin America: Growth outlook hampered by sticky inflation

September 25, 2024

Growth in Latin America (Latam) is expected to slow in 2024 to 1.6% from 2.0% in 2023 and then pick up to 2.2% in 2025 and 3.3% in 2026. Recent data on the second quarter of 2024 remained sluggish, held back by persistent inflation and interest rates. Sticky inflation has left central banks retaining a hawkish tone and prompted many to slow the pace of easing policy. A challenging fiscal environment will keep public finance in the spotlight. A tailwind from rate cuts is expected to boost growth more in the out years than in 2024. 

• Argentina: Inflation is still too high on an annual basis, but the underlying readings are cooling and supporting growth.
• Brazil: High inflation and fiscal risks have led to a stricter tone from the central bank. After a strong second quarter reading on GDP, the bank chose to hike at its September meeting.
• Chile: New electricity tariffs dampened consumption in the first half, leaving Chile with little momentum.
• Colombia: Investment will continue to struggle from low household savings combined with a challenging fiscal environment.
• Mexico: Persistent currency depreciation, elevated services inflation and a slowdown in GDP have complicated the job of Mexico’s central bank.
• Peru: Growth accelerated in the second quarter, the lone Andean economy to avoid a contraction. Early data on economic activity suggests a sharp decline over the summer.
• Uruguay: Growth is expected to slow into 2025 as household recovery falters.
• Venezuela: Risks are skewed to the downside due to the potential for new or renewed sanctions on oil markets. 

Consumer spending is expected to slow as labor markets cool and household savings increase. Consumers in Mexico, Chile, Colombia and Peru have held up better than elsewhere in the region but are expected to feel the crimp of cooling labor markets and slower wage gains in the second half of the year. Consumer sentiment has been ticking down among most economies, while savings are starting to rebuild after being depleted during and after the pandemic. Recent currency depreciation, particularly in Mexico, could also weigh on spending for some time. Policies in some countries, like electricity tariffs in Chile, have added to household stress.

Brazil is an outlier. A tighter labor market and higher wage growth have led to a stronger consumer in 2024. The unemployment rate has fallen, participation is lower than pre-pandemic and wage growth picked up earlier in the year. That has added to inflation concerns for central bankers but has avoided the stronger slowdown that was expected this year. A more hawkish central bank will slow spending later this year and in 2025. Argentina will benefit from slower inflation, rising real wages and consumption. 

Domestic investment has suffered amid higher rates but could rebound as central banks continue their easing cycles. The main risks to investors include uncertainty surrounding fiscal policy, central bank policy and supply chain-related disruptions. For example, the start of a La Niña cycle this year could hit agricultural exporters in South America.

External investment has taken off over the past few years. The region has been a major recipient of the near-shoring and friend-shoring trends that came out of the pandemic-era supply chain disruptions. Brazil and Mexico were among the top recipients of foreign direct investment in 2023 according to the OECD. Chile and Colombia are two other top locations for new investments in supply chains due to geographic and resource advantages.

The review process of the US-Mexico-Canada (USMCA) free trade agreement could be devastating for investment in Mexico. If the agreement is not approved, that could set off a process that would make expiration of USMCA more likely. The main sticking points will be potential judicial reforms in Mexico and content requirements for manufacturing of high-tech industries and electric vehicles. 

Improvements in inflation in Latam have stalled and remain at the high end of the target range for most central banks in the region. Higher-than-expected services inflation, boosted by strong tourism and shelter costs, are the main culprits. A jump in the minimum wage in many countries is showing up in higher services inflation, given the outsized role labor costs play in service sector prices.

Argentinian inflation has dropped to an average of just over 4% for four months in a row as of August; in January, the monthly pace was near 21%. That is significant progress but not enough for fiscal and monetary authorities to let their guards down. 

We still expect inflation to fall in the region, but with much slower progress than in 2023. In 2025, most countries will see inflation continue to hover around the upper end of target ranges, keeping central banks on high alert.

Recent currency depreciation is a hurdle. Latam currencies fell as markets priced in fewer cuts by the Federal Reserve while a larger sell-off in August followed the release of a weak US jobs report. Most currencies have rebounded since then, with the notable exception of Mexico. The peso is depreciating not just from central bank policy, but from (1) a surprise cut by Banxico in August and (2) rising concerns about judicial reform. Argentina’s currency may also be volatile moving forward; the large gap between the official and unofficial rate will need to be absorbed. The beginning of the Fed’s easing cycle should help support most Latam currencies going forward.

Central banks in the region found themselves in an enviable position last year. Their early rate hiking cycles had brought down regional inflation near target ranges, so central banks in Chile, Brazil, Mexico, Colombia, Peru and others were able to begin loosening policy. Since then, inflation has become increasingly sticky.

Central banks have in large part stuck to our forecast of slowing, rather than reversing, their easing cycles. In addition, they have adopted a hawkish tone on further rate cuts, citing the persistence of inflation in their statements. That has caused markets to lower their expectations for cuts and tighten without an actual increase in policy rates. Brazil is the only central bank that has completely reversed course and raised rates.

We expect central banks to continue with their slower pace of cuts through the rest of the year and into 2025. Colombia and Mexico are the only economies expected to continue their easing cycles at a similar pace because both started the easing cycle later. Chile and Peru have already changed their tone and slowed down cuts.

The only central bank that has reversed course is the Banco Central do Brasil (BCB), which has been dealing with tight labor markets and loose fiscal policy after being one of the first to ease policy. The bank signaled more hikes for future meetings but is likely to restart the cutting cycle at a slower pace next year when activity is expected to slow even more.