Itaú BBA - CHILE – Monetary Policy Meeting Minutes: An even more gradual tightening cycle

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CHILE – Monetary Policy Meeting Minutes: An even more gradual tightening cycle

February 14, 2019

We still see space for the normalization process to continue in 2H19, but risks are tilted to fewer hikes.

The minutes from the January monetary policy meeting show an increasingly more cautious central bank. The board is uncomfortable with the disappointing growth in core economies and lower-than-expected inflation at home, while it is less certain on structural parameters – such as neutral rates and potential growth – that guide policy decisions. Although the board unanimously voted to hike the policy rate by 25-bps (to 3.0%), many board members indicated there are multiple paths consistent with the 4Q Inflation Report (IPoM). This suggests that the central bank could take a more cautious approach in the short-term even if it opts to maintain the goal of fully normalizing monetary policy by the first half of 2020 (something that is becoming less likely, in our view).

Even though the board remained upbeat with domestic activity figures available at the time of the meeting, the board emphasized that downside risks for growth have increased due to international developments. For the next IPoM (to be released on April 1) the board noted a comprehensive focus needs to be placed on anticipating future global dynamics and the possible transmission channels to the Chilean economy. The board showed particular interest in clarifying how factors such as the trade conflict and monetary policy responses abroad would be reflected on the domestic economy. The minutes noted that the generalized reaction of central banks across the globe to signal greater caution could reflect the recent recovery was driven by expansionary monetary policy rather than a structural upturn. If so, the international economy would be weaker than underlined in the baseline scenario. 

Despite the upbeat view on activity evolvement, the board was concerned by the impact weaker-than-expected consumption could be having on inflation. Inflation in December was below the central bank’s expectations. The technical staff believed the divergence was due to specific factors (lower inflation of highly volatile services), adding that prices more sensitive to the output gap, continued to rise steadily. Part of the board noted core inflation could be responding to a delayed exchange rate pass-through, which could reverse shortly, while others considered it could be reflecting weaker-than-expected domestic demand, given that low inflation was widespread. The board labelled it a priority task to decipher the relevance of each scenario for inclusion in the upcoming IPoM, while continuing to revise the structural parameters that guide monetary policy decisions (potential growth, output gap, and neutral interest rates). The flagship report will also address the changes associated to the new inflation basket, which were unknown at the time of the meeting and revealed an even lower inflation rate.

Hiking the policy rate in January was the clear choice given that the baseline scenario remained relevant. Aiding the decision was the market’s anticipation of a hike and the distance from neutral levels that allowed for a low-risk hike. However, one board member focused on the path ahead, eager to convey that further monetary stimulus withdrawal would be done with greater flexibility, indicating that a slower normalization cycle could unfold. The other option debated in the meeting was stable rates, which had the benefit of seeing how the external scenario evolved and affected the Chilean economy, but was overshadowed by the risk that it could signal an unwarranted change in the baseline scenario.

We believe that weaker activity momentum at the beginning of the year, short-term uncertainty of inflation dynamics following the introduction of the new CPI basket and still elevated external risks support a more cautious central bank. Hence, we expect the upcoming IPoM to reinforce a flexible rate guidance, in line with the posture adopted by other central banks. We still see space for two rate hikes (to 3.50%) during the second half of the year, but risks are tilted to fewer hikes.

Miguel Ricaurte
Vittorio Peretti

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