Itaú BBA - CHILE – Monetary Policy Meeting Minutes: The brakes are on

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CHILE – Monetary Policy Meeting Minutes: The brakes are on

April 15, 2019

The central bank has gone fully neutral

The minutes of the decision to hold the policy rate at 3.0% in March reaffirm the view that higher rates are still expected in the medium-term, but low inflation has led to a long pause in the normalization cycle. The board was unanimous in its decision, and stable rates was the only option discussed. This is the first meeting since June 2018 when the option to hike was not on the menu. The updated scenario in the Inflation Report (IPoM; published the following working day after the decision) showed that a slower convergence path for inflation to the target and risks tilted to the downside on the external front warranted a more gradual normalization cycle. In the IPoM, the central bank indicated that the policy rate is likely to be kept unchanged, at 3.0%, for at least the next two quarters, while neutral levels (currently estimated by authorities at 4%-4.5%) are expected to be reached towards the end of the policy horizon (around 1H21). In the December report, the policy rate was expected to reach neutral a full year earlier (first half of 2020). The board explained that this flexibility of strategy displays the cautious approach it had proposed for this cycle.

The focus on risks from abroad has intensified. How emerging economies react to a strengthening US dollar as global trade weakens was flagged as one of the key issues to monitor. Unlike previous slowdown cycles, the origins of the weakening were varied and understanding the relative importance to Chile of each element was essential in building a view on the effect of the external cycle on the domestic economy.

Postponing the removal of monetary stimulus was deemed prudent by all board members. Lower than expected inflation under the new CPI basket was partly explained by a larger slack in the labor market (as migrant inflow likely led to higher short-term potential GDP, the IPoM elaborated), as well as lower exchange rate pass-through and structural changes in certain markets, delaying the return to the 3% target by around a year. Moreover, there was uncertainty surrounding the structural parameters, namely potential growth and the neutral interest rate, something that would be addressed in the June edition of the IPoM. We believe the likelihood of neutral rate estimates being lowered (from the current range of 1%-1.5% for real rates) is high.

The minutes show that uncertainty persists about the net impact of shocks. While the minutes state that the negative shock from abroad on activity could be cancelled out by the migration inflow (domestic shock), both events imply lower inflation ahead. Hence, for this reason, the minutes note that the focus (at least for now) should be on the evolution of inflation, rather than that on the output gap.

We expect only one further 25-bp rate hike this year (in 4Q19), taking the policy rate to 3.25%. Low inflation, the looser policy stance by the Fed and risks to global economic growth suggest there is no need to remove stimulus rapidly in the near term. Two further hikes during 2020 are expected assuming the economic recovery endures.

Miguel Ricaurte
Vittorio Peretti

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