Itaú BBA - A cautious central bank

Scenario Review - Chile

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A cautious central bank

April 12, 2017

We still expect a 100-bp easing cycle, taking the policy rate to 2.5% by yearend

Please see the attached file for all graphs. 

• Investment remained the main drag on activity in 2016, contracting for the third consecutive year. A major labor strike at the largest copper mine in February and March has dented activity further. The labor market continues to hint at less support for private consumption ahead; meanwhile, business confidence is still subdued. In this context, only a mild improvement in activity is expected this year, aided by higher copper prices, stronger global growth, falling interest rates and lower inflation.

• A more stable currency and weakening domestic demand have driven inflation to the lower half of the range around the central bank’s target. Going forward, we expect inflation to remain below 3% for the rest of the year.

• The central bank signaled that only one more 25-bp rate cut is on its way, in spite of the economic weakness and low inflation. We expect that because economic data fails to show a notable recovery ahead and inflation remains low, the central bank will eventually cut rates some more. We continue to see two additional rate cuts this year, one in 2Q17 and the final cut (to 2.5%) coming in 2H17.

A slow start to 2017 follows a weak ending last year

At the end of 2016, economic activity grew at the slowest pace since the financial crisis. Activity in the final quarter of 2016 was dragged down by shrinking investment and declining exports. Meanwhile, private consumption remained the main contributor to activity growth, while the administration’s effort toward fiscal consolidation meant public consumption moderated significantly. At the margin, activity contracted 1.4% qoq/saar, after the +3.5% qoq/saar in 3Q16, due to lower fixed investment. Distressed private sentiment and the conclusion of the tax-incentivized construction boom led to lower investment. Overall, activity in 2016 floundered with growth of only 1.6%, a slowdown from 2.3% in 2015 and the lowest growth since the 1.6% drop in 2009.

The 43-day strike at the largest copper mine means that activity starts 2017 on a weak footing. The monthly GDP proxy (IMACEC) contracted 1.3% year over year in February (+1.4% in January), the lowest growth rate since October 2009. Corrected for calendar (leap-year) and seasonal factors, activity remains weak, growing a mild +0.5% year over year in the quarter ending in February (0.8% in 4Q16), with mining activity falling 6.1% (-3.3% in 4Q16). Meanwhile, non-mining activity grew a weak 1.1%, stable from 4Q16.

As economic growth remains frail, the unemployment rate continues to rise and the quality of jobs created deteriorates further. The unemployment rate came in at 6.4% in the quarter ending in February, up 0.5 percentage points from one year before. The number of jobs created is near the 2015 historical lows. Meanwhile salaried employment contracted 2.1% from one year earlier (-0.1% in 4Q16), the largest annual decline since the international financial crisis. With no meaningful economic turnaround expected in the near future, we see the labor market continuing to loosen and support for private consumption diminishing.

Prospects of a significant recovery this year are limited. Countering the positive effect of higher copper prices, falling inflation and declining interest rates, are the weak carry-over effect, the mining strike (which could mean a loss of output in 2017) and uncertainty ahead of the presidential elections. We see GDP growth of 1.8% this year (1.6% last year), with a recovery to 2.5% next year.

Narrowing of the current-account deficit continued in 2016 

Chile’s current-account deficit remains low. In 4Q16, the current account recorded a USD 700 million deficit, taking the full-year deficit to USD 3.6 billion (-1.4% of GDP), after a USD 4.7 billion deficit in 2015 (2.0% of GDP). Our own seasonal adjustment shows the current-account deficit is even lower at the margin, at 0.7% of GDP (1.9% in 3Q16), the smallest deficit since 3Q14. Due to higher copper prices and weak internal demand, there was an improvement in the trade balance for goods and services. 

Foreign direct investment shrank to USD 12.2 billion in 2016 (4.9% of GDP), from USD 20.5 billion in 2015 (8.4% of GDP), the lowest value (in dollar terms) since 2006. Still, net direct investment at USD 5.1 billion (USD 3.7 billion in 2015) continues to fully finance the current-account deficit.

With higher copper prices and internal demand set to remain weak, Chile’s current-account deficit will likely remain at low levels in the short term, although we note that the mining strike has an adverse impact on the trade balance in the short term. We now expect a current-account deficit of 1.2% of GDP this year (1.6% previously), broadly stable from the 1.4% seen last year. With internal demand likely to show some recovery, a widening to 1.7% is expected for next year.

The peso continues to perform well as copper prices remain elevated. Going forward, the expected hikes from the Fed and further easing domestically will result in some weakening of the Chilean peso. We see the exchange rate at 675 pesos per dollar by the end of the year, with further weakening to 695 pesos per dollar by the end of 2018.

Stable and low inflation

Inflation remains below the 3% target, while weak growth hints at low inflation ahead. In March, annual inflation was stable at 2.7%, completing six months below the 3% target. Inflation excluding food and energy prices stayed low and steady at 2.2%, while other core inflation measures are hovering around the lower bound of the range around the target. Core services inflation inched down 0.1 pp to 3.3%, a comfortable level that confirms the lack of demand-side inflationary pressures. In fact, the latest wage inflation data (for February) showed further moderation (to 4.2% year over year from 4.4% in January). Our diffusion index shows more consumer items posting inflation below the 3% target than above it.

We expect inflation to stay low for the remainder of the year. We continue to see inflation ending the year at 2.8% (2.7% in 2016) and to be at the 3% target by year-end 2018.

More easing ahead

In March, the central bank of Chile completed the easing cycle indicated in the 4Q16 inflation report, by cutting the policy rate to 3.0%. The central bank initiated the cycle with a quarter-point cut in January, then strategically pausing in February.

The Inflation Report (IPoM) published after the meeting revealed that the new baseline scenario includes one additional 25-bp cut in the near term. According to the central bank board, the policy rate would be in line with asset prices in the lead up to the publication of the report. Additional monetary-policy support was deemed necessary amid a downgraded growth outlook for this year – to 1%-2%, from 1.5%-2.5% in the 4Q16 edition – and the concern over the evolution of the labor market.

We believe that more than just the one additional rate cut will likely materialize. Growth continues to disappoint and inflation will likely remain below the 3% target for the remainder of the year. We expect the next rate cut to come in 2Q17, with the final cut to 2.5% to come in 2H17, concluding a 100-bp easing cycle.

Trouble attracting undecided voters

Sebastián Piñera and Alejandro Guillier still top Adimark’s March presidential poll, but the number of undecided voters remains elevated. Former-presidentPiñera retained the same four-percentage-point lead over left-leaning Guillier; however, both candidates’ support fell two percentage points from the previous month, according to pollster Adimark. Piñera, who officially launched his candidacy last month, is most likely to be the candidate for the center-right coalition. During the announcement of his candidacy, Mr. Piñera indicated that he would seek to change some key aspects of the reform agenda pushed by the Bachelet administration, including taxes and higher education. On the left, Ricardo Lagos (Chile’s president from 2000 to 2006) announced he will not run for president following the Socialist Party’s endorsement of Mr. Guillier. The decision clears the way for Mr. Guillier to become the governing coalition's presidential candidate. Important to note is the increase in the number of undecided voters, to 29% from 25%, which shows that in spite of the slight gap Piñera currently has over Guillier, there is still a significant part of the public that needs convincing. This group of voters will remain crucial to the outcome of the presidential election at the end of the year.


João Pedro Bumachar

Vittorio Peretti

Miguel Ricaurte

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