Itaú BBA - CHILE – Monetary Policy Meeting Minutes: Uncertainty over recovery

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CHILE – Monetary Policy Meeting Minutes: Uncertainty over recovery

July 31, 2020

We expect the policy rate to remain at 0.5% and a boost to the QE measures in response to any significant deterioration of conditions.

The minutes of the July monetary policy meeting show all board members agreed that, given the macroeconomic context under the pandemic, keeping the policy rate at its 0.5% technical floor and consolidating the forward guidance of low-for-long was the only valid option. Regarding the use of unconventional measures, the board agreed that the decision to increase stimulus in June (by around 10% of GDP) had been validated, which justified keeping them in place. Of concern during the meeting was the possible increase in volatility that would compromise financial stability, as the pension reform bill under discussion at the time would lead to significant asset sales. Additionally, while fiscal and monetary measures had led to a positive evolution of commercial credit, data suggested that a credit-risk problem was still significant and might be escalating. In this context, the central bank noted that particular efforts had to be taken to ensure that the stricter quarantines and weaker activity would not imply firms going from facing a liquidity problem to a solvency one. The latter would result in distinct consequences for the economy and require a different response package.

On the global front, the gradual reopening of economies led to some marginal activity improvements and a recovery of business and consumer expectations. Nevertheless, all variables remained well below pre-pandemic levels and significant risks persisted (mainly due to the recent resurgence of Covid-19 in several countries, and restated confinements in some places). Central banks and fiscal authorities had maintained their efforts or made additional economic policy announcements, holding on to their highly expansionary tone. Meanwhile, commodity prices had picked up, driven particularly by a more favorable outlook for China and, in the case of copper, also by supply-side factors (disruptions in Chile and Peru). 

Domestically, the macroeconomic scenario was unfolding in line with the 2Q20 IPoM scenario as the evolution of the Covid-19 pandemic wreaked havoc with the economy. Data for 2Q20 confirmed a significant activity slump, with contractions spread across all sectors. Exports had shown greater resilience than the board had expected. The latest import numbers showed some stabilization, after the significant falls in previous months. Expectedly, business and consumer expectations remained significantly downbeat. Meanwhile, preliminary information drawn from the Business Perceptions Report showed an unravelling labor market. Some respondents expected to implement layoffs and most said that they expected no further hiring in the near future. Hence, more respondents than not anticipated that employment would recover at a slower pace than activity.

The board at the time commented that the extended quarantine period might lead to increased bankruptcies, which coupled with a loosening labor market would affect the economy’s ability to recovery. This was seen to be particularly complex in a context that the political cycle was introducing more uncertainty about the future evolution of the economy. Nevertheless, on the upside, health indicators had evolved favorably, allowing some regions to begin reducing the confinement measures. Meanwhile, the domestic financial market retained high liquidity levels, with interest rates aligned with the central bank’s forward guidance. The board agreed that commercial loan growth showed that the stimulus measures provided by various public entities were helping to provide significant financing flows to companies, which were vital to overcome the economic emergency caused by the pandemic.

A key question on central bankers’ minds was how sustainable the economic recovery would be. The board members agreed that the increased monetary stimulus continued to help ensure that commercial credit, backed by the established guarantees plus regulatory measures, continued to sustain the productive sector, while the asset purchase program had been well received. However, it was difficult to envision the robustness of an economic recovery. In this context, the board believes the role played by public policy is even more important (especially regarding the rehiring of workers, restructuring of companies and the administration of financial conditions and obligations). 

Central bankers also focused on what effect the 10% pension fund withdrawal reform could have on the economy, considering its impact on both the financial markets and domestic demand. They agreed that there was no obvious policy response, beyond the fact that the necessary measures should be implemented to ensure that there would be no excess volatility that would compromise financial stability. Since the July meeting, as the bill became law, the board announced a series of measures that will start next week to preserve financial stability. The measures include a special program of spot purchase operations carried out jointly and simultaneously with the forward sale, on the open market, of eligible instruments issued by banking companies. The total amount of the program is up to USD 10 billion offered with 1 and 3-month sales terms. Additionally, the central bank will continue with the March bank bond purchase program (USD 4.1 billion remaining). Finally, the central bank will also buy as much as USD 8 billion in term deposits. The programs will be in force for a period of six months, with weekly quotas announced the preceding Friday. Considering that the pension funds manage around USD 200 billion, the measures announced would be sufficient to cover the short-term liquidity needs that could unfold under an exhaustive 10% pension withdrawal. As a result, excessive currency or interest rate changes (given the liquidation of both domestic and USD denominated assets to finance the payout) would be contained.

We expect the policy rate to remain at 0.5% for the near future. Further rate cuts are not our base-case scenario, but they cannot be ruled out, as revision of structural parameters in the central bank’s September IPoM may open the door to reducing the estimated technical floor of the policy rate. Meanwhile, we expect a boost to the QE measures in response to any significant deterioration of external or domestic conditions.


Miguel Ricaurte
Vittorio Peretti

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