Itaú BBA - CHILE – Monetary Policy Report: Inflation surprises hold the key to more easing

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CHILE – Monetary Policy Report: Inflation surprises hold the key to more easing

September 6, 2017

Central bank takes a cautious approach following stronger data at the margin.

The central bank’s 3Q17 inflation report (IPoM) differs little from the previous edition in that the board sees no need for further easing in the baseline scenario, and a normalization process is not on the near horizon. The central bank implemented a 100-bp easing cycle (to 2.5%) in the first five months of the year as the economy weakened, while inflation remained under control. Since the previous edition of the IPoM, inflation for this year has evolved below expectations, meanwhile, activity has not deteriorated further. The baseline trajectory for the policy rate considered by the central bank would depart from various surveys in the lead up to the publication of the report (including one 25-bps rate cut before yearend) and our expectation of two additional rate cuts before yearend. However, the board left the door open to rate cuts if inflation underwhelms, as they see risks tilted to the downside.

Lower inflation so far this year is deemed to be primarily explained by transitory factors, and medium-term expectations are anchored at the 3% target. The yearend 2017 inflation expectation dropped to 2.4% (in line with Itaú; 2.9% previously), with the expected average down to 2.3% (2.6% previously). Core inflation is seen at the lower bound of the target range by yearend (2.0%, 2.1% in the previous report), likely dragged down by falling good price inflation on the back of a firmer exchange rate. Next year, inflation is expected to close at 3.0% (2.8% previously), but average 2.7% (2.9% previously). The board expects the real exchange rate, currently below the 15-20 year average, to moderately depreciate during the forecast horizon.

The central bank’s outlook for growth is mainly unchanged with an expected recovery ahead. The 2017 growth forecast range was narrowed to 1.25%-1.75% (Itaú: 1.3%), raising the lower bound by 25-bps from the previous IPoM. Within the growth breakdown, total consumption is broadly stable at 2.7%, while the drag from net exports is larger. Meanwhile, gross fixed investment is expected to shrink 1.6% this year (-0.8% in 2016), worse than the 0.9% decline expected in the 2Q17. Hence, the forecasted growth in GDP for this year implies a notable accumulation of inventories (in line with the data since 4Q16). Turning to next year, the growth forecast range was retained at 2.5%-3.5% (Itaú: 2.5%), boosted by a recovery in investment to growth of 3.2% (3.0% previously). Total consumption is seen broadly stable at 2.8%. Externally, the growth expectations for trading partners remained broadly stable this year and for 2018, at 3.5%. The copper price outlook was lifted to $2.75 for this year and 2018, likely on the back of the recent rally, up around $0.20 from the previous report.

The board now sees downside risks to inflation in the short-term. In presenting the IPoM to the Senate, Governor Mario Marcel acknowledged that if these risks materialize, convergence to the target could be jeopardized and, hence, additional easing would be required. With the economy remaining weak in our view, along with a currency that has strengthened from the beginning of the year, inflationary pressures could remain muted and so the possibility of rate cuts remains open. For the medium-term, the inflation risk is deemed balanced. 

Meanwhile, the board sees the risks to the growth scenario as balanced. Yet, (short-term) potential growth was lowered to 2.5% for 2017, from 2.8% estimated one year ago, likely responding to temporary factors. On the other hand, the medium-term outlook remained unchanged, with trend growth unchanged at 3.2% (3%-3.5% range), in line with our expectations.

Today’s report means that in the most likely scenario, the central bank sees the easing cycle over. Nevertheless, the comments from Mr. Marcel show that future development hinge largely on whether the downside risks to inflation materialize, so we still see easing is on the cards. Monetary policy changes will depend on incoming inflation data.


Miguel Ricaurte
Vittorio Peretti


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