Incoming data also supported a more cautious stance on the economy's prospects heading into 2Q. A better-than-expected gain in consumer spending in February pointed to somewhat better but still sluggish GDP growth in 1Q. We raised our 1Q GDP estimate to +2.1% from +1.7%, after boosting our consumption estimate to +2.1% from +1.6%. The surge in consumption in February after several soft months wasn't matched by a rise in income, however, so the savings rate plunged 0.6pp to a four-year low of 3.7%, putting consumers on a less solid footing ahead of potential rising budget pressures as we move towards the seasonal highs in gasoline prices. Meanwhile, the durable goods report showed only a relatively sluggish rebound in capital goods orders and shipments in February that extended a weak trend since mid-2011 and left business investment on pace for sluggish growth in 1Q. Looking ahead to the key run of March data in the coming week, early indications were muted. Jobless claims now show no improvement from the mid-February to mid-March survey periods for the employment report, pointing to some moderation in job growth. Regional manufacturing surveys have been broadly softer ahead of the ISM release. And early indications for consumer spending have been mixed after the upside in February, with sales reports from auto companies expected to show some slippage after the surge to four-year high in February.
After the Friday afternoon pullback, benchmark Treasury yields ended the past week mixed, with modest gains in the short and intermediate parts of the curve but small losses at the long end. The old 2-year yield fell 3bp to 0.32%, 3-year 5bp to 0.50%, old 5-year 6bp to 1.02%, old 7-year 4bp to 1.59%, and 10-year 2bp to 2.21%, but the 30-year yield ended 3bp higher on the week at 3.34% after backing up 7bp Friday. Pressure on oil prices on discussions by a number of countries about releasing strategic reserves weighed on TIPS relative performance somewhat. Flow through to gasoline prices was limited, however, with May WTI prices down 3.5% on the week but May gasoline only down 1%. And at $3.32 a gallon, the May gasoline contract was only a bit below the high of $3.38 hit Monday and was still at a level consistent with retail prices running up to a national average record of around $4.20 a gallon from $3.92 in the latest week and levels near $3.25 in December. The 5-year TIPS yield fell 4bp to -1.25%, 10-year yield rose 1bp to -0.13% and 30-year yield rose 6bp to 1.91%. The 5-year-led gains in Treasuries on the week were supported by a shifting back out of the expected timing of the first Fed rate hike in futures markets. The January 2014 fed funds futures contract rallied 6.5bp to 0.41%, July 2015 9.5bp to 0.625% and January 2015 10.5bp to 0.94%. Those rates are still higher than the closes on March 12 ahead of the FOMC meeting of 0.37%, 0.535% and 0.79% and still price the first rate hike coming about a year earlier than the FOMC's guidance. But there's been a sizeable partial reversal of the hawkish repricing seen in the week after the FOMC meeting through March 20, when the rate on the January 2014 contract was 14bp higher than Friday's close at 0.55%, July 2015 20.5bp higher at 0.83% and January 2015 25bp higher at 1.19%. Along with this reversal, the MBS market continued to trade a lot better over the past week after significantly underperforming the Treasury market losses seen in initial reaction to the FOMC meeting. Fannie 3.5s outperformed the gains in the Treasury market by about 4 ticks over the past week.
Data released the past week pointed to somewhat better, but still muted GDP growth in 1Q. We raised our 1Q estimate to +2.1% from +1.7%, after the unrevised 3.0% gain in 4Q. 4Q growth was mostly a result of a hefty 1.8pp boost from inventory building, with final domestic demand - consumption, business investment, residential investment and government spending - up only 1.3%. The inventory boost in 4Q was adjusted down slightly, however, and this pointed to slightly less of drag in 1Q. But the bigger boost to the 1Q outlook came from a surprisingly strong 0.5% gain in real consumption in February. Auto sales and ex auto retail sales posted decent gains, in line with previously released reports, while real services spending surprisingly jumped 0.4%. Although the weather remained unusually warm, and the Fed's IP report didn't show any upside in utility production, BEA reported a 6% rebound in real electric and gas utility spending after a near-record 13% drop in the prior three months. Ex utilities real services spending was also robust at +0.3%, but some of this reflected unusually large gains in particular categories (like movie theaters spiking 24%) that are unlikely to be sustained. Still, the February upside boosted our 1Q consumption estimate a half-point to +2.1%. The durable goods report also left the outlook for business investment in 1Q near a muted 2%. Core capital goods orders (+1.2%) and shipments (+1.4%) both rebounded in February, but after steep declines in January both are running down in 1Q from 4Q, extending a sluggish run since mid-2011. We see business investment growth slowing to near +2% in 1Q.
In line with the still sluggish outlook for growth in all of 1Q, early indications for the initial run of key economic data for March to be released in the coming week were muted, and we expect some moderation in growth in payrolls, a modest level for the ISM, and a bit of a pullback in motor vehicle sales. Jobless claims data releases in recent weeks had been showing some stalling out of the major improvement from mid-September to mid-February that tracked the pick-up in job growth to an average of 223,000 a month from October to February. This recent flattening out in claims became more pronounced with the release of annual seasonal adjustment revisions, with the four-week average of initial claims now close to unchanged between the February and March employment report survey weeks. We expect this to be reflected in some moderation in job growth in March as the boost from the extremely mild winter weather starts to fade. We look for non-farm payrolls to be up 175,000 in March and for the unemployment rate to hold steady at 8.3%. To the extent that weather did have a significantly positive impact on job growth in the winter months, payback would likely be most significant in April. The weather remained much warmer than normal across most of the country into the end of winter in mid-March, and the seasonal factors in April will be looking for a large pick-up in seasonal hiring, with actual job growth of about 900,000 needed for a flat reading in seasonally adjusted payrolls.
Meanwhile, the second round of regional manufacturing surveys released over the past week - Dallas Fed, Richmond Fed, Kansas City Fed and Chicago PMI - all showed slower growth in March after the mixed Empire State and Philly Fed results. An average of all six on an ISM-comparable weighted average basis fell to 54.6 from 55.8, with broad signs of slower growth in orders, production and employment. The national ISM was significantly lower than suggested by the regions in February, however, falling 1.7 points to 52.4 as a result of an unusually big drop in the supplier deliveries gauge. This will probably rebound somewhat in March and help keep the ISM composite stable, but we look for softer underlying results for orders, production and employment. Finally, after the big gain in February consumer spending following a few sluggish months, initial indications for March retail sales are expected to be mixed. After rising from 13.5 million in December to 14.1 million in January to a four-year high of 15.0 million in February, auto sales this year are likely to show a big rise from the 12.7 million sold in 2011. Our auto analysts boosted their forecast for sales for all of 2012 to 14.8 million from 14.0 million (see Autos & Auto-Related: US Consumer Back at the Wheel: Raising 2012 SAAR est. to 14.8 MM by Adam Jonas, Ravi Shanker and Yejay Ying, March 27, 2012), and we have the same assumption in our US economic forecasts. They expect sales to pull back to 14.5 million in March, however, as surging gasoline prices have weighed somewhat on the near-term sales outlook (see Autos & Auto-Related: Leading Indicator Slips On Rising Gas Prices, March 26, 2012). Early indications for March chain store sales, on the other hand, have been positive, with the unusually warm weather supporting early strength in spring clothing sales (see Retail, Softlines: Greenberger's Look at the Mall (GLAM): Momentum Motoring Through March by Kimberly Greenberger, Jay Sole, Laura Ross, March 19, 2012), though that could imply some front-loading and less upside in the spring.
In addition to the upcoming week's key run of initial economic data for March, the other key item on the calendar is the release of the minutes from the March 13 FOMC meeting on Tuesday. The substantial hawkish repricing of the fed funds rate outlook and scaling back of expectations for additional Fed asset purchases in the first week after that meeting now appears clearly to have been an overreaction. Most of the post-FOMC meeting losses have been reversed over the past week-and-a-half, with help from dovish speeches from Fed Chairman Bernanke and New York Fed President Dudley and a run of mostly sluggish economic data that has called into question the increasingly upbeat economic outlook many investors had been starting to adopt. The minutes could provide additional impetus for further reversal of the initial post-FOMC meeting hawkish repricing if the description of the overall tone of the discussion is in line with the cautious outlook expressed by President Dudley and Chairman Bernanke. Note that most markets will be closed on Good Friday when the employment report is released, but bad luck on the calendar and the BLS not observing the holiday mean bond market participants will miss a three-day weekend for the second time in the past three years. The SIFMA recommended bond market close is noon on Friday, but many investors will probably be heading home earlier than that.
Notable data releases due out in the coming week include ISM and construction spending Monday, factory orders and motor vehicle sales Tuesday, the ADP survey Wednesday, chain store sales Thursday and the employment report Friday:
* We look for the manufacturing ISM composite index to be unchanged at 52.4 in March. Almost all of the regional results showed some deterioration in March on an ISM-weighted basis (the sole exception was Empire). However, the level of the ISM is already somewhat lower than that of the regional indices. Moreover, the supplier deliveries component of ISM showed an unusual fall-off in February, and we could see normalization in this month's report. So, we look for the ISM to be unchanged relative to the February reading.
* We look for a modest 0.7% rebound in construction spending in February following the surprising downtick seen in January. The pick-up in housing starts over the course of the past few months points to some modest underlying momentum in the residential category. And private non-residential activity had risen for five straight months before slipping back a bit in January. Of course, unusually favorable weather conditions across much of the country should also be providing some support at this point.
* A sizeable jump in the durables category, together with an expected boost in non-durables tied to higher energy prices, should lead to a solid 1.5% gain in overall factory orders in February. Meanwhile, shipments should edge up 0.2%, with inventories rising 0.8% on some price-related upside in non-durables.
* We expect motor vehicle sales to pull back to a 14.5 million unit annual rate in March following the strong 15.0 million unit pace in February. Anecdotal comments suggest that milder-than-usual weather across much of the nation has been an important contributor to the recent pick-up in car buying. Also, the impact of production disruptions has finally abated, and there is increased availability of popular models. The major negative at this point is the headwind associated with rising gasoline prices.
* We forecast a 175,000 gain in March non-farm payrolls and a steady 8.3% unemployment rate. The pace of improvement in jobless claims moderated in March. Indeed, on a survey week-to-survey week basis, the four-week average for claims was unchanged following a 12,000 drop in February. Also, while weather conditions continue to be remarkably favorable across much of the country, this factor becomes less relevant as we move through the winter months. So, payroll growth is expected to moderate relative to the +245,000 pace seen over the course of the prior three months. Finally, we look for the unemployment rate to hold steady as labor force participation shows signs of flattening out.
A good year for Latin America is shaping up to be an even better year. While we still expect the pace of economic activity this year to be a bit below that seen during the robust recovery period in 2010 and early 2011, data release after data release points to another year of above-trend growth for the region.
Indeed, since we last conducted a region-wide review of growth just over four months ago, our forecast for regional real GDP growth has risen to 3.9% from 3.5%. And in light of our global economics team's just released country-by-country review, it seems like the opportune time to review our call for the region's largest economies for 2012.
Cutting Tail Risks, Boosting Tailwinds
Two things have changed since our global team's last full-scale review: policy action has helped to reduce a headwind to our forecasts, while our increasingly upbeat view on China should boost a tailwind for activity. It is hard to debate the first change since last November: policy action. Last November, our global economics team expected to see a significant policy response forthcoming; indeed, it was what kept our warning that the globe was skirting dangerously close to a recession from becoming our base case. I have to admit that I was skeptical at the time and indeed still have my concerns. But whether you are a euroskeptic or not, it is difficult to deny that the ECB's decision to flood the banking system with more than a €1 trillion in cheap three-year loans has helped to cut off the tail risks in 2012.
And my global colleagues argue that the policy support is not over yet: From the US to Europe and from China to some emerging economies, we see policy support from central banks in the pipeline. The world economy, as our global economist Joachim Fels puts it, is likely "to keep stumbling along rather than falling hard".
The more controversial call - our upbeat view on China - runs counter to the concerns of many China watchers worried about a weaker outlook for 2012. But our China economist, Helen Qiao, now expects 9% real GDP growth in 2012, up from the previous forecast of 8.4%, largely on the back of additional policy support, especially in infrastructure projects as well as new support for housing and the property sector.
As was the case with our European team's relatively upbeat view on Europe's outlook last year, I continue to adopt the discipline that our forecasts should not be based on a series of suppositions that the Latin American economics team decides to make about the globe, but on our best work to map out how we think Latin America will respond to the global outlook as presented by our colleagues around the world. The task for forecasting 2012 in Latin America is complicated a bit by the fact that while our China forecasts are bucking the consensus, our overall global outlook has moved up only marginally to 3.7% real GDP growth this year from 3.5% last November and our global team continues to worry that the risks remain skewed to the downside.
Latin America Better Still
In Latin America, the most important changes since our last full review come in Peru and Colombia, where Daniel Volberg sees growth in both economies this year in excess of 6%.
In contrast, the most surprising outcome of our forecast review was Arthur Carvalho's decision not to increase Brazil GDP growth further, but to keep it at 3.5% for 2012. Arthur sees more inflationary risk in Brazil from stronger Chinese demand (as well as from the current policy stance in Brazil), but argues that the greatest impact of a stronger China growth story is likely to be seen in pressure on the Brazilian real to strengthen further. Hence, Arthur reiterates the call for the Brazilian real to trade near 1.70 by year-end 2012. What is good for the currency however is clearly not good for Brazil GDP. Indeed, it is precisely the prospect of a strong currency that leaves us concerned about output in Brazil, even as consumer demand is likely to be supported by the purchasing power of the currency. Both Brazilian policy and the latest upgrade to our China view are conspiring to produce the return of the Growth Mismatch in Brazil.
Base and Risk
Our narrative of the region has changed little since last November. Then as now, we remain a bit cautious, particularly because the greatest risks to Latin America's outlook come from abroad and hence are hardest for us to handicap (the Risks to Abundance).
But also now, as then, we reaffirm our view that absent a pronounced global downturn, Latin America should present good growth. And then as now we argue that in Brazil the policy mix in place appears to set the economy up for another bout of too much domestic demand. What we appear to have gotten wrong last November was not our base case, but our focus on the risk around that base case: those risks simply have not materialized. Fortunately for us, our base case was founded on our global team's relatively benign outlook (see "Latin America in 2012: The Risks to Abundance Return", This Week in Latin America, November 28, 2011).
I'd highlight three elements that we've seen in place since last November. Each, I believe, should help as we think through the remainder of the year.
No Legs to the Downturn
First, the downturn in activity in Latin America has failed to have legs. The softening that had many worried late last year has been largely limited to 3Q11 and, to one degree or another, almost all of the releases since then have shown a turnaround. Again, this was part of our base case and indeed most Latin America watchers seemed to have expected the turnaround. But still, I have been surprised how few Latin America watchers have been aware of just how uniform the sequential improvement has been.
Look for example at Brazil: from PMI releases in industry and services to formal job growth, the turnaround has been very clear. The odd statistic that did not fit this trend - January's industrial production - in contrast seems to have gotten the bulk of the attention of many Brazil watchers I've spoken with. The difficulty with the January downturn is that it appears to have been largely linked to very specific difficulties in the heavy vehicles industry, and the first signs are that February should provide a rebound on a sequential basis. Indeed, if you look at the diffusion index for Brazilian industrial production, you see no signs of a new downward trend at the start of 2012 - instead, the diffusion index suggests that industrial output has stabilized. Still, with February's IP report likely to show a strong downturn on a year-over-year basis, many will probably continue to argue - mistakenly in our view - that the downturn continues.
And the turnaround has not been limited to Brazil. In Chile, after the economy suffered from the weakest pace of growth in 3Q since the earthquake of early 2010, the economy has begun to "fire on all cylinders" in the words of Luis Arcentales. In Mexico, the monthly GDP proxy IGAE declined sequentially in August and again in October, leaving average growth during that thee-month stretch at just 0.3% annualized. By January, the three-month trend in monthly GDP was back up to almost 5%. Or look at Peru, where the monthly GDP proxy slowed to just 0.7% annualized pace in the three months through October before rebounding to a 6.2% annualized pace in the three months through January this year.
Of course there are exceptions. Colombia's economy remained very strong late in 2011 and indeed played a role in prompting the central bank to continue to hike interest rates in November and again in January and February. And Argentina's output appears to be slowing because of new fiscal tightening measures designed to squeeze demand and engineer a soft landing. In addition, measures introduced to curb access to US dollars and imports late last year and early this year may have exacerbated the slowdown in Argentina by hurting confidence. But from Brazil and Chile to Mexico and Peru, the broadest trend in the region has been to bounce back quickly from the jolt seen in 3Q.
Manufacturing Epicenter
Second, the epicenter of the weakness has been on the industrial and manufacturing fronts, not on the consumer demand side. Again, Brazil provides perhaps the strongest example here: weakened industrial output suffered even more during the downturn and while we believe that output is now stabilizing, the strongest growth continues to come from consumer demand. Retail sales growth is still below its 2010 double-digit growth rates, but has continued to show positive strength. In Chile, despite the weakness in mining and manufacturing in 3Q which slowed the pace of 3Q GDP growth, consumption and investment remained on a solid uptrend. In Mexico, while manufacturing came to a near standstill during the most difficult period - slowing below 1% annualized between August and October - the services sector continued to post 4.7% annualized growth. The same was reflected in the labor markets, while the economy, excluding industry, continued to create jobs at a solid pace of almost 5% between August and October. Meanwhile, hiring in manufacturing softened materially, approaching 1% annualized - the weakest three-month period since employment bottomed in mid-2009.
More Inflation
Third and finally, the contrast between the temporary downturn in manufacturing and the relatively resilient indicators of domestic demand suggests the region is likely to continue to face inflation pressures in 2012. With the exception of Brazil and Venezuela, we expect to see higher inflation prints in every country in the region in 2012 than 2011 even though growth is slowing a bit from the run-rate seen in 2010 and early 2011. And even in the case of Brazil where Arthur's forecasts for 2012 and 2013 are below the 6.5% reached in 2011, inflation is set to move away from the 4.5% target during most of the forecast period. The difficulty is that the policy measures appear to be designed to boost demand (and Arthur is concerned about inflation as well), but boosting demand can actually be counter-productive for the industrial base, which is suffering from a loss in competitiveness that may be only worsened by higher wage costs (see "Brazil: Boosting Demand, Boosting Inflation", This Week in Latin America, March 26, 2012).
Bottom Line
A good start to the year has turned even better for Latin America. And if our global team's assumptions hold up for the year, Latin America should produce another year of above-trend growth. However, the greatest challenges for the region in the near term remain the risk from abroad, the Risks to Abundance. However, while I'll continue to monitor those risks in 2012, I suspect that the greatest risk to long-term growth in the region remains not the challenges from abroad but the internal challenges to build stronger infrastructure. Latin America's growth path beyond the dips and turns of 2012 is likely to be a function of policy focus on improving the region's physical infrastructure, its human capital infrastructure and its regulatory infrastructure. And on that front, much more needs to be done.
Brazil: Growth Mismatch Is Back
Faced with a structural growth challenge and a struggling industrial sector, the authorities seem to be overly focused on boosting cyclical demand. While this should not create an imminent problem - in fact, we believe that inflation should be well behaved in the next few months - lower interest rates are likely to continue to boost demand and tighten the labor market. In fact, we expect that the central bank will cut another 75bp in April and hold rates at 9% until late 2013, when we believe that it will have to initiate a modest hiking cycle of 100bp to limit inflation to 6.2%. In turn, we are concerned that the labor cost pressure will make the industrial sector even less competitive and will continue to struggle to generate sustainable growth, unless protected from imports by tariffs. We continue to expect 3.5% GDP growth for 2012, while we now expect a higher current account deficit (3.2% of GDP, up from 3.0% earlier) due to stronger imports pick-up as a response from the stronger demand.
The most important impact from our new global revisions to Brazil continues to be in the currency, as our China numbers have turned even more upbeat. Despite the looser-than-previously-expected monetary policy, we believe that the currency will appreciate again once the news flow in China materializes as our team is forecasting. We expect the real to strengthen to $1.70 this year and reach $1.65 in 2013. We look for the administration to continue to intervene in the currency market and be somewhat successful in avoiding even further appreciation.
Demand is already showing signs of a strong rebound, after a weaker 2H11. The Brazilian consumer is back on a shopping spree before credit has accelerated significantly, due to a strong pick-up in income growth. Real wages are up 4.5% compared to 2011: this should continue to fuel a very positive domestic demand story. Although this may not create an inflationary problem for 2012, given that there are a series of one-offs - such as a negative consumer energy price adjustment in São Paulo - this will likely continue to pressure services prices. Indeed, we are concerned that this will create a more troubling inflationary problem in 2013: we now expect 6.2% inflation in 2013. This will likely eventually force the central bank to resort to interest rate hikes in late 2013 after trying to use only macro-prudential measures to curb inflation. (A. Carvalho)
Mexico: The Link Cuts Both Ways
Mexico's economy is enjoying a healthy growth dynamic characterized by expanding domestic demand coupled with rising industrial exports and output (see "Mexico: Regaining Momentum", This Week in Latin America, January 16, 2012). After experiencing a temporary manufacturing-led slowdown in 2H11, growth in Mexico rebounded sharply by late 2011 and maintained very strong momentum in early 2012, prompting us to upgrade our GDP forecast modestly for this year to 3.5% from 3.2% previously. At a time when domestic demand - which remained remarkably resilient despite softness in export-linked sectors in the latter half of last year - is already growing at a solid pace, the relevant external backdrop for Mexico has improved as our US team upgraded its forecast for industrial production growth to 3.9%, only a slight slowdown from last year (4.2%). Importantly, in this cycle Mexican manufacturers have been benefiting disproportionately from the upturn in external demand, likely reflecting an improved competitive position; indeed, manufacturing in Mexico is up 21% in the 32 months since its mid-2009 bottom compared to just 14% for the US, in sharp contrast to the previous cycle when the recoveries were almost equal in magnitude (see "Mexico: In Manufacturing We Trust", This Week in Latin America, December 19, 2011). Given lingering slack in labor markets, contained inflationary pressures and our expectations for only modest exchange rate appreciation ahead, this should allow manufacturers to keep unit labor costs in check and prevent an erosion of their competitive position. Indeed, several of these factors have played a role in keeping services inflation near historically low levels, providing room for the central bank to remain on hold. Though we have removed our call for 50bp of easing by year-end and see rates staying on hold, we expect the central bank's tone to remain dovish and disagree with the growing number of Mexico watchers who expect the central bank to tighten policy by early 2013.
With the economy on solid footing, the focus of Mexico watchers is likely to turn to the upcoming July 1 presidential election. Whether the campaigns - which were officially launched only at the end of March - provide surprises or whether the current lead by the PRI candidate turns out to be too large for his rivals to overcome, ultimately the challenge for policy-makers is to refocus on the country's unfinished reform agenda. With Mexico likely to experience healthy growth in 2012 and 2013, the new administration should take advantage of this favorable growth backdrop to boost the country's competitiveness via changes on the energy and labor fronts, addressing informality as well as lack of competition in some key sectors. (L. Arcentales)
Argentina: A Return to Orthodoxy?
The slowdown in Argentina's economy that started in 3Q11 is likely to be persistent. Indeed, after growing at a double-digit pace during 1H11, starting in 3Q the economy slowed towards a sequential growth pace of near 3%. We expect that pace of activity to persist as we forecast GDP growth at 3.1% in 2012 and 3.0% in 2013. While global factors may have contributed to the slowdown in 3Q, we suspect that domestic factors were the main drivers. We suspect that the single most important factor underpinning the persistence of the downshift in activity may be fiscal tightening that was put in place starting in mid-August last year, after the nationwide primaries signaled the president's landslide reelection. After all, the authorities have cut roughly 0.6% of GDP in expenditures since 3Q11. And the tightening in capital controls introduced late last year was a negative shock to confidence in Argentina, an additional factor that may explain the slowing in activity. Looking ahead, we expect a soft landing of the economy as the combination of official pressure on labor unions to settle for flat real wages and continued cuts to energy and public transportation subsidies squeeze demand and thus bring down the pace of economic activity. Meanwhile, import controls introduced in February this year raise the risk of an even sharper deceleration in activity that could morph into a hard landing. (D. Volberg)
Chile: Unfinished Agenda
While the Chilean economy recovered strongly from the slowdown in 3Q11, we have maintained our growth outlook unchanged at 4.1% real growth in 2012. The strong 8.2% sequential annualized jump in 4Q GDP likely marked the high point, in our view, and activity is likely to cool off in coming months. Headwinds offsetting part of the benefits from stronger external demand and growth in China include some deterioration in the terms of trade caused by higher crude prices, to which Chile is the most vulnerable economy in the region (see "Latin America: Oil Risk to Abundance", This Week in Latin America, March 12, 2012). Even before the latest upturn in oil pushed gasoline prices higher in March, Chileans were already turning more cautious about inflation: in February 60% thought prices would go up by "a lot" in the next 12 months, up from 50% six months ago. While tight labor markets should remain an important factor supporting good consumption growth, they also represent - combined with higher crude - a challenge for the inflation outlook. In turn, we now see less room for the central bank to provide monetary stimulus and expect rates to end at 4.75%.
Beyond the swings in the business cycle or monetary policy, the upcoming discussions about the tax reform are likely to have important implications for years to come. The authorities have already signaled that they will make permanent the temporary increase in corporate taxes to 20%, originally triggered by the earthquake rebuilding efforts, in a step towards financing growing spending commitments with permanent sources of revenues. The challenge for the policy-makers will be to approve a tax reform that succeeds in its primary goal of boosting revenues without creating disincentives for investment and improves spending efficiency, including areas like education (see "Chile: The Unfinished Agenda", This Week in Latin America, October 31, 2011). (L. Arcentales)
Colombia: Strong Macro
Economic growth in Colombia has proved nearly immune to global confidence shocks. During 3Q11, while market concerns about global activity intensified, Colombia's economic growth hardly budged - slowing to a pace of 6.2% annualized from 6.4% annualized during 1H11. And economic growth strength in Colombia remains broad-based, underpinned by strong investment, household consumption and exports. Looking ahead, we reiterate our GDP growth forecast of 6.7% in 2012 and 4.9% in 2013, driven by a combination of global and domestic factors. On the global side, we expect continued support from elevated oil prices as Colombia becomes an increasingly important oil exporter, as well as a boost to non-commodity exports as Colombia begins to enjoy the first benefits of the free trade agreement with the US. And domestic factors are likely to remain supportive as well - confidence is high and investment plans are ramping up. While inflation is well anchored for now, we expect the strength of economic activity to prompt the central bank to tighten monetary policy further by hiking rates by an additional 75bp to 6% by year-end. (D. Volberg)
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