Itaú BBA - About to cut

Scenario Review - Chile

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About to cut

December 8, 2016

Low growth and disinflation will lead to rate cuts beginning in January.

Please see the attached file for all graphs. 

• A weak beginning to the fourth quarter adds a downside risk to our growth forecast. Low private confidence still stands in the way of a meaningful activity recovery.

• Inflation would slow to 2.8% by the end of next year from 3.0% in December 2016 as the exchange rate remains stable and the output gap remains negative.

• In this environment, as long as financial conditions for emerging markets do not deteriorate significantly more, the central bank would start cutting rates in January, taking the policy rate to 2.5% by the end of next year from 3.5% this year.

• The Chilean peso has recently outperformed its peers because of higher copper prices, but rate hikes in the U.S. and a loosening cycle in Chile would put some pressure on the currency in 2017.

• The 2017 presidential election is becoming a two-horse race as surprise candidate Alejandro Guillier gains ground on former President Piñera.

Short-lived stabilization of activity

Economic activity remained weak in the third quarter of the year, dragged down by investment. The demand-side breakdown shows a mild pick-up in private consumption, while there was some moderation of public consumption. Net exports made a positive contribution to growth. GDP expanded 1.6% year over year in 3Q16, while there were upward revisions of 0.1 percentage points both in 1Q16 (to 2.3%) and in 2Q16 (to 1.6%).

Weak investment put an end to the gradual recovery of final domestic demand (2.0% year over year, from 2.8% in previously). Gross fixed investment fell 1.2%, after a 3.0% increase in 2Q16 as expenditure in machinery and equipment slowed down sharply, while construction activity continues to contract. With the end of the tax incentive that favored a housing boom and overall business confidence remaining low, the outlook for investment remains gloomy. Consumption expanded 2.9% (2.8% in 2Q16), with the private consumption component picking up, offsetting the public-consumption slowdown. On the external front, lower sales of manufactured goods led the deceleration of exports from 0.9% in 2Q16 to 0.5%. Meanwhile, imports of goods and services declined, so net exports contributed positively to growth.

The economy showed some (probably temporary) improvement in 3Q16. GDP increased 2.5% qoq/saar, recovering from the 1.4% qoq/saar decline in 2Q16.

However, activity in the 4Q16 got off to a weak start. The monthly GDP proxy (Imacec) contracted 0.4% year over year in October, below expectations. Activity in the month was dragged down by the 7.1% year over year decline in mining and the slowdown of non-mining activity, which was pulled down by manufacturing. With the disinflation process unfolding at a faster-than-expected pace, real wage growth has picked up and is likely supporting consumption. At the margin, activity in the quarter was near flat.

Additionally, the continued loosening of the labor market could limit the performance of consumption. While unemployment (6.4%) remains low, the composition of employment growth and the continued exit of workers from the labor market point to a deterioration of broad labor-market conditions. Waged employment was flat in the quarter ending in October from one year ago. Within waged employment, contracted workers declined 0.4% (+1.8% in 2015), hinting that jobs created could be more temporary than permanent. Self-employment, characteristic of lower quality jobs, expanded 7.0% year over year (4.2% in 3Q16 and 6.0% in 2Q16).

The disappointing activity data at the start of 4Q16, alongside stagnant confidence levels, put a downward bias to our growth scenario. Following the publication of 3Q16 national accounts, we anticipated our growth forecast for this year would be revised to 1.8%. However, the weak October Imacec compensates for the upside revision to growth in the first half of the year, so we maintain our previous month’s 1.5% growth forecast for 2016, down from 2.3% in 2015. We still expect a modest recovery to 2.0% next year, but acknowledge there is a downside bias to this forecast. 

Low inflation consolidates

Inflation was once again low in November. Following a sharp depreciation of the currency over the past two years, the evolution of the peso this year has led to a tradable goods-led disinflation in recent months. Moreover, disinflation of non-tradables (a component of inflation that the central bank is closely monitoring) is indicative that there is more than transitory factors behind the fall of inflation in Chile.

Annual inflation came in at 2.9%, from 2.8% in the previous month, remaining near the target. The uptick is due to an unfavorable base of comparison. Tradable inflation continues to float near the lower end of the target range at 2.2% (1.9% previously). Meanwhile non-tradable inflation entered the target range, standing at 3.9% (4.1% previously), the first time this has happened since the introduction of the 2013 CPI basket. Inflation excluding food and energy prices came in at 3.0% (3.2% previously), the lowest since March 2014. Core services inflation, more closely related to domestic inflationary pressures, decelerated to 3.9%, entering the central bank’s target range for the first time since December 2013 (3.8% inflation).

Our diffusion index is still retreating and sits at its lowest level since April 2014. The bulk of the moderation came from tradable goods prices. In fact, tradable good prices are now contributing negatively to the index.

We still expect inflation to slow to 2.8% by the end of next year from 3.0% in December.

Case for easing gains traction

The tone of the November monetary-policy meeting minutes, when the central bank board voted to leave the policy rate unchanged at 3.50%, shows that the case for easing is gaining traction. The board is anticipating inflation forecasts will be adjusted down in the upcoming Inflation Report (IPoM), to be published on December 19.

Although the board agreed to stay on hold at the November meeting, the internal debate raised the expectation for rate cuts in the future. Several board members saw that recent data had led to a material change to the inflation trajectory (vs. 3Q16 IPoM), which increased the probability of monetary stimulus in the near term. A further board member agreed, but noted that the possible adjustment would be small and not significantly different from that seen in asset prices (between one and two 25-bp rate cuts at the time). One member went as far as saying that rates could be cut at the October meeting, but he favored not surprising the market.

As long as financial conditions for emerging markets do not deteriorate significantly more, we expect the central bank to start cutting rates in January. The easing cycle would come only after the central bank lays out its new forecast scenario in the 4Q16 IPoM. We see the policy rate at 2.5% by the end of next year, but consecutive rate cuts are unlikely. In fact, we do not expect the central bank to signal a full-fledged easing cycle as early as the upcoming IPoM.

Stable and low current-account deficit

The current-account balancedeficit is stabilizing. In the rolling four-quarter period ending in 3Q16, the deficit came in at USD 4.8 billion (-2.0% of GDP), after a USD 4.9 billion deficit as of 2Q16 (2.1% of GDP), broadly flat from the USD 4.8 billion recorded in 2015.

The improvement in trade balance of goods and services compensated the deterioration in the income balance. The income deficit increased and now sits above the 2015 amount, as copper prices have picked up from the beginning of the year, likely leading to improved results for foreign mining companies.

Foreign direct investment moderated in the four quarters ending in 3Q16, but mostly due to a high base of comparison. Foreign direct investment shrunk to USD 11.5 billion (4.8% of GDP), from USD 20.5 billion in 2015 (8.5% of GDP), reaching the lowest value (in dollar terms) since 2006. Meanwhile, net direct investment continues to fully finance the current-account deficit.

While the current-account balance has stabilized, we do not expect much of an improvement toward year-end, so we now see a current-account deficit of 2.0% of GDP this year (1.7% previously). A slower adjustment of the income balance will lead to a wider deficit than we had expected this year. We expect the current-account deficit to remain broadly stable at 1.9% of GDP next year.

With copper prices behaving favorably following the expected fiscal expansion in the U.S., the Chilean peso has mostly outperformed its regional peers. We continue to expect the currency to end this year at 675 to the dollar and at 685 by the end of 2017. The weakening would be due to the narrowing interest-rate differential with the U.S. 

Presidential election turning into a two-horse race

The November Adimark public opinion survey showed that support for the two presidential front-runners picked up ahead of next year’s election. Voting intentions for former President Piñera increased four percentage points, to 24%. Surprise candidate Alejandro Guillier rose to 21% from 15% previously (5% two months ago). Guillier is an independent left-wing senator and former journalist who entered the political fray in 2013. The growing support for Guillier may reflect the overall discontent with the traditional political class.

Former president Ricardo Lagos still lags in third spot with only 7% (5% previously). While undecided voters have fallen from 47% in August to 31% in November, uncertainty remains elevated. An election between former presidents Piñera and Lagos would be seen as market friendly, meanwhile Guillier provides the element of surprise.


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs. 


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