Itaú BBA - CHILE – Monetary Policy Report: Still-uncertain scenario calls for prolonged monetary impulse

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CHILE – Monetary Policy Report: Still-uncertain scenario calls for prolonged monetary impulse

December 9, 2020

Investment dynamics would play a key role in the CB’s reaction function.

The central bank’s final monetary policy report (IPoM) of 2020 shows the persistence of heightened uncertainty, reflected in use of a range estimate for growth this year (versus the traditional point estimate at this time of the year). The evolution of the pandemic and its effects on individual and business income will continue to determine the pace of the economic recovery. Overall, the central bank reiterates that it will maintain significant monetary impulse for a prolonged period of time to support the closing of the output gap. In particular, it anticipates that the policy rate will remain at its technical floor of 0.5% for most of the two-year monetary policy horizon (similar to previous signaling). Nevertheless, the board notes that if the risk of further health and economic hardships materialize from subsequent waves of the virus, it would be necessary to evaluate actions that increase the monetary impulse (likely through the expansion of the use of unconventional liquidity and QE measures).

The economy is recovering, but challenges remain. The central bank outlines that measures taken to support households and credit have managed to limit the threat posed to the well-being of the population and the solvency of companies. However, the less favorable evolution of sanitary restrictions, the slow recovery of activities most affected (services) and the repercussions left by the crisis have had a negative impact on the dynamism of the recovery, affecting not only aggregate demand, but also the supply response. Consequently, the expected drop in activity this year will be greater than anticipated in September (-6.25/-5.75% vs. -5.5/-4.5%).

The baseline scenario’s gradual recovery path projects activity returning to September 2019 levels by 2022. The projected scenario considers that the evolution of the pandemic will allow for greater mobility than those of the middle of this year, and that during 2021 the vaccination process will advance. The second withdrawal of pension savings will have a relevant effect on consumption and activities related to trade next year. Likewise, that the fiscal stimulus will continue to be positive, and that the Chilean economy will receive a somewhat greater external boost than previously contemplated, with a copper price averaging USD 3.15 per pound over the next two years. Meanwhile, investment is improving but at a slower-than-expected pace. While there has been a rise in copper prices, weakened financial situation of businesses (lower profits, higher indebtedness) and uncertainty (mainly of the reemergence of social unrest) may deter the undertaking of new projects. In this context, GDP is seen growing between 5.5% and 6.5% in 2021 (4-5% in 3Q IPoM) and 3 to 4% in 2022. The Report emphasizes that, although health risks seem more balanced, particularly in the medium term, the aftermath of the crisis suggests an economic outlook with risk biased downwards for activity.

Despite short-term fluctuations, the medium-term inflationary pressures remain contained. The boost to the consumption of tradable goods due to the withdrawal of pension savings caused a transitory fluctuations of some prices in recent months. Yet, beyond these short-term movements, medium-term inflationary pressures remain limited amid the gradual closing of the large output gap. Market expectations have taken into account the transitory nature of price movements, observing changes in shorter terms and stability near the 3% target for the relevant two year horizon. Inflation is still seen ending 2020 at 2.8% and 2.6% next year, with slightly higher averages during both years. Core inflation is expected to fluctuate near the 3% target at the close of this year and the next. The central bank’s scenario considers risks to the inflation scenario to be symmetrical.

Under the current set of assumptions, the board continues to believe the economy requires a significant boost to ensure the consolidation of the recovery and the fulfillment of its objectives. While the potential materialization of short-term risks could mean expanding the monetary stimulus, medium-term term risks are more contained given the advancement of the virus vaccine. The development and rollout of the vaccines would help eliminate some supply restrictions and generate a faster and more robust recovery in demand. Nevertheless, investment weakness will be monitored and if more persistent than anticipated, the lower demand could reduce medium-term inflationary pressures that could lead to rates remaining at its technical floor of 0.5% for longer than signaled, while possibly deepening the use of unconventional measures.

The still-wide output gap, along with anchored inflation expectations support the retention of significant monetary stimulus going forward. We see rates stable at 0.5% throughout 2021 and part of 2022. Additionally, use of unconventional measures will be data dependent.

Miguel Ricaurte
Vittorio Peretti

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