Chile: All Reasons Lead to a Longer Pause

Chile: All Reasons Lead to a Longer Pause

Nader Nazmi - Market Economics
Latam Macro Snapshot | 01 Apr 2013 21:13 |

According to the minutes of the 14 March monetary policy meeting, there are good reasons to cut and there are good reasons to hike. But, on balance, all reasons lead to a longer pause.

We read the minutes as neutral regarding the short-term outlook, ruling out any changes in the policy rate over the forecast horizon. According to the minutes, the policy rate remains within a neutral range and the decision to keep it steady at 5.0% was unanimous.

The board sees global risks broadly unchanged since its last meeting. The outlook for global growth is judged as consistent with that presented in the latest Monetary Policy Report (IPoM), although risks stemming from the eurozone persist. Conditions in the US have improved, and growth in China has stabilized.

Hike option considered and dismissed. The minutes underscore the fact that labour and domestic markets remain tight. There are signs of stretched capacity, and domestic demand growth remains rapid, outpacing potential output growth. This has not resulted in high inflation because of the peso appreciation, productivity gains and the fact that increased imports have covered the excess demand. The end result has been increased pressure on the current account. Such pressures, however, are not to be addressed through monetary policy. In addition, inflation remains in check and is expected to remain low in the coming months on the back of lower international food prices. The option of increasing the policy rate is also constrained by external factors and the fact that the local interest rate is significantly above foreign interest rates.

Cut option considered and dismissed. In a global context, Chile – along with Peru and Malaysia – are among only a few emerging economies that have not reduced their policy rate in the last 15 months. Most interest rate cuts have not been motivated by anti-cyclical considerations and, instead, are used as defensive moves against monetary easing in advanced countries. In addition, notwithstanding the economy’s rapid growth, inflation remains below the floor of the bank’s 3.0%±1.0pp target range. However, the minutes show some concern about latent price pressures given the economy’s strong momentum. Low inflation is driven, in part, by transitory factors and may revert in the medium term. A rate cut is inconsistent with the domestic economy’s strong growth momentum.

Remaining on hold is the only option. Given the above discussion, remaining on hold appears to be the only policy option. This situation is expected to continue over the forecast horizon. We expect Q1 Monetary Policy Report (IPoM) that will be released tomorrow to lend additional support to the view that the policy rate will remain unchanged over the forecast horizon. As such, we no longer see a policy rate hike by mid-year as a possibility. We believe the pause will continue into next year, and the next policy rate moves will be two 25bp hikes in H2 2014, owing to normalizing external conditions and rising domestic price pressures.