Itaú BBA - CHILE – Monetary Policy Meeting: Reaffirming low-for-long (but not forever) rates and no government

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CHILE – Monetary Policy Meeting: Reaffirming low-for-long (but not forever) rates and no government

September 1, 2020

Government bond purchases could be used to address liquidity issues, but not boost aggregate demand.

The board of the central bank of Chile unanimously agreed to keep the policy rate at 0.5% at its September meeting, as widely expected, while reinforced its stance of retaining the significant impulse for a prolonged period to aid the economic recovery. The board signaled the policy rate would likely be kept at its technical floor of 0.5% for “most” of the two-year forecast horizon, a slight adjustment from the messaging in previous meetings that referenced the entire forecast period. Nevertheless, we note that a full quarter has passed since that stance was established in the 2Q Inflation Report (IPoM), and the start of a normalization cycle during 2022 was already implied by the rate corridor. We expect an updated baseline scenario of a milder GDP decline and higher inflation, to be unveiled in tomorrow’s 3Q IPoM, to justify the signaling that some stimulus is likely to be removed during 2022. Meanwhile, the board reaffirmed the unconventional policy measures in place that include credit support facilities of up to USD 40 billion (USD 27 billion utilized) and asset purchases of USD 16 billion (USD 5.5 billion used). Despite the recent constitutional and legal adjustment allowing for the purchase of treasury bonds in the secondary market, the board did not activate this tool as favorable financial market developments, in line with external movements, have likely eased concern over imminent risks to financial stability. This decision, combined with forward guidance of future rate hikes, convey the message that the central bank is willing to buy government bonds to address potential liquidity issues, but not as a mean to keep long term yields low and boost aggregate demand (at least given the current information set). Also, the probability of downward revisions to the technical minimum level for the policy rate seems even lower now.

 

On the external front, economic activity is recovering from the lows registered between April and May as the health response to the pandemic improved in many countries. High monetary and fiscal stimuli have been maintained, and lower volatility of the financial markets have contributed to an improvement in commodity prices. The price of copper has exceeded USD 3.0 per pound mainly due to the reactivation of state-led investment in China.

 

The Chilean economy is showing signs that the worst of the shock has passed, but activity remains far inferior to the levels prior to the pandemic and the deterioration of the labor market is striking. Sectors such as commerce and manufacturing are showing signs of recovery, while others where face-to-face work and physical interaction are essential, remain severely affected. Key factors behind the economic evolution include the gradual withdrawal of lockdown measures, the increase in credit to companies, and the promotion of various measures to support the people's income (cash transfers and pension withdrawals). As a result, private sentiment has improved marginally from historic lows and supported an improvement in imports of consumer and capital goods during August. The income support measures have also led the board to expect reduced downside inflationary pressures, compared to the 2Q IPoM scenario (2.0% yearend call). The relevant two-year inflation outlook remains closely anchored to the 3% target. Nevertheless, the broad-based decline in employment (around 20% yoy), labor income and hours worked reflect the severity of the economic shock.

 

We expect stable rates at 0.5% throughout this year and 2021. Despite signals that the economic decline may be milder than initially anticipated, there remains notable uncertainty that favors retaining the significant monetary stimulus to help consolidate the economic recovery.

 

Miguel Ricaurte

Vittorio Peretti



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