Itaú BBA - CHILE – Inflation Report: Low inflation requires low rates for longer

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CHILE – Inflation Report: Low inflation requires low rates for longer

April 1, 2019

Arrival to neutral rate delayed to 1H21.

Following on from Friday’s decision to keep the policy rate stable, the central bank’s flagship Inflation Report (IPoM) sees a significantly more gradual normalization process. The policy rate is likely to be kept unchanged at 3.0% for at least the next two quarters, while neutral levels (4%-4.5%) are expected to be reached towards the end of the policy horizon (24 months, so around 1H21). In the previous report, the central bank saw the policy rate reaching neutral by the first half of 2020. Additionally, the board announced the 2Q IPoM (June) will include revisions to the neutral rate and potential GDP growth. We believe the likelihood of neutral rate estimates being lowered (from the current range of 1%-1.5% in real terms) is not negligible. Overall, the Chilean central bank is following the global liquidity tide, while also reacting to domestic developments that reflect a slower inflation convergence to the 3% target, hence justifying the retention of the monetary stimulus for longer than previously anticipated.

A slower convergence of inflation to the 3% target is now expected, partly due to methodological changes. Since the 4Q18 IPoM, the statistics agency published inflation utilizing the new consumer basket, including several methodological changes (with apparel, telecommunications and tourism packages standing out). In this context, the central bank reduced the yearend forecast to 2.6% (from 2.9% previously) with the average for the year down to 2.0% from 2.7% in the December report. Nevertheless, low inflation is seen as transitory with the 2020 yearend forecast remaining at the 3% target and the average for the year only 0.1pp lower at 2.9% compared to the 4Q18 version. Revisions to core inflation follow a similar pattern (yearend 2019 revised to 2.4% from 3.1% in 4Q18; while 3% is still seen for next year). < /span>

However, the IPoM notes that low inflation goes beyond the methodological changes. Reduced pass-through from exchange rate depreciation compared to historical levels is highlighted. This could be explained by the Chilean peso reacting to global variations of the dollar, rather than to idiosyncratic shocks (as was the case in 2017). Additionally, low inflation could be linked to structural supply-side changes leading to heightened competition in several markets. Example of these are the automotive industry (which saw mild price changes despite large exchange rate fluctuations), the emergence of low cost alternatives in transportation, and greater competition in the telecommunications industry. Finally, according to the central bank, the labor market presents a greater degree of slackness due to the impact o f immigr ation in recent years, as noted in the business perception survey that shows wage pressures are contained.

As expected, disappointing mining production resulted in the growth forecast range for this year being shaved by 25bps to 3%-4% (4% in 2018). Meanwhile, the forecast range for next year was raised by 25bps to 3%-4%, expected to benefit from supply shocks (the absorption of immigrants in the labor market). Meanwhile, the 2021 growth outlook was published for the first time (2.75%-3.75%), around our calculation of potential. The consumption outlook was unchanged at 3.3% this year (3.7% in 2018), with some improvement to 3.5% next year (3.4% in 2021). Investment remains the expected driving force behind activity with mining investment still leading. Gross fixed investment growth was revised up to 6.2% for this year (6.0% previously), and 4.3% for next year (3.9% previously; 3.9% for 2021). Overall, the output gap is s een to be larger than previously estimated, as migrant inflow likely led to higher short-term potential GDP.

We expect only one further 25bp rate hike towards the end of this year, taking the policy rate to 3.25%. With domestic risks symmetrical, downside risks to the external scenario and the slower inflation convergence path provides room to retain monetary stimulus for longer. This is consistent with a more accommodative stance from global central banks.


Miguel Ricaurte
Vittorio Peretti

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