Itaú BBA - Easing-cycle discussion still alive

Scenario Review - Chile

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Easing-cycle discussion still alive

November 6, 2017

Limited inflationary pressures mean that we cannot rule out additional rate cuts.

Please see the attached file for all graphs.
 

• Low inflation, an expansionary monetary policy, improving private sentiment and higher global growth will all aid an activity recovery. We expect growth of 1.7% this year (1.6% in 2016) and a pick-up to 2.7% next year.

• We see year-end inflation at 1.8% for this year and we still see inflation ending next year at 2.8%. However, the risks are tilted to the downside. Limited inflationary pressures mean that we cannot rule out additional rate cuts.

• Having revised our copper price forecasts up, we now see the Chilean peso ending the year at 650 per dollar (665 previously), and 660 by the close of 2018 (675 previously). Higher copper prices are consistent with a narrower current-account deficit (1.2% of GDP for 2018, from 1.4% in our previous scenario).

• On November 19, Chileans will vote to elect a new president. However, a December 19 runoff vote will likely be needed to determine Michelle Bachelet’s successor. Former-president Sebastian Piñera and Alejandro Guillier (supported by the majority of the ruling coalition) are the best positioned among the pool of eight candidates to proceed.

Recovery gains traction

Growth momentum improved in the third quarter of the year. The rebound of mining activity is currently the main driver of better growth figures; however, non-mining activity has shown some consolidation as well. The Imacec (monthly proxy for GDP) grew 1.3% year over year in September (2.4% in August). Once corrected for seasonal and calendar effects, growth in September was somewhat higher at 1.8% (2.2% in August). Overall, the Imacec rose 2.2% in the third quarter (0.9% in 2Q17), with mining up 7.6% (-3.0% in 2Q17). With the recovery of mining production from the extensive labor strike earlier in the year along with elevated copper prices, mining will likely continue to lift year-over-year activity growth for the remainder of the year (even though a significant moderation in quarter-over-quarter rates is likely). Meanwhile, non-mining activity is gaining momentum, increasing 1.7% in the quarter (1.3% in 2Q17).

In line with an activity recovery, business confidence continued to advance toward the neutral level, recording its highest level since April 2015. Think-tank Icare’s October business confidence index posted its 43rd consecutive month in pessimistic territory (< 50), but gained 6.2 percentage points from October 2016 to reach 49.0 points (48.3 in the previous month). The improving confidence levels could be associated with higher copper prices, an improved outlook for the local and global economy and optimism about the impact of the political cycle.

Meanwhile, household credit demand continued to strengthen in 3Q17. Demand for consumer credit and mortgages expanded in 3Q17, while supply is less tight, according to the central bank’s quarterly survey of credit conditions. With inflation low and an expansionary monetary policy, the improvement in private sentiment could be favoring the demand for loans, which in turn would aid the expected recovery of the Chilean economy.

We see higher global growth (supporting copper prices), expansionary monetary policy and improving sentiment driving an activity recovery going forward. We forecast growth of 1.7% this year and 2.7% for 2018. The outcome of the general election and the debate over the reform agenda next year will have a significant influence on confidence, and consequently on investment and growth.

Comfortable trade surplus in 3Q17

Mining exports, supported both by stronger volumes and higher prices, boosted the trade balance. A USD 1.5 billion surplus was recorded in 3Q17 (USD 1.4 billion in 2Q17), taking the rolling 12-month trade surplus to a comfortable USD 5.6 billion, above the USD 5.3 billion seen in 2016, reaffirming low external vulnerabilities for Chile. Our seasonally adjusted series shows that, at the margin, the trade-balance surplus picked up to USD 12.2 billion (annualized) in the third quarter of the year, from the USD 2.6 billion annualized surplus recorded in 2Q17 (USD 1.1 billion in 1Q17), largely due to mining.

In the third quarter of the year, export growth picked up to 17.7% year over year (8.0% in 2Q17 and 4.7% in 1Q17) as copper exports recovered further to 24.5% (16.8% in 2Q17 and 1.0% in 1Q17). At the margin, exports accelerated to 69.9% qoq/saar (7.6% in 2Q17 and -10.7% in 1Q17), lifted by an acceleration in copper mining and agriculture exports. Meanwhile, import growth in 3Q17 was the slowest so far this year. Part of the slowdown can be explained by the moderation in energy imports.

As internal demand is still weak, the effects of the mining strike continue to fade and copper prices stay higher than previously expected, the current-account deficit will likely be low. We still see a current-account deficit of 1.4% of GDP this year, in line with the deficit recorded in 2016. However, next year, we now expect the deficit to narrow to 1.2% of GDP (1.4% previously).

As a result of higher copper prices, we now see the exchange rate ending the year at 650 pesos per dollar (665 previously) and ending 2018 at 660 pesos per dollar (675 previously). The weakening from current levels is based on the likelihood of continued monetary-policy normalization in the United States.

Inflation underwhelms

Consumer prices came in well below market expectations in the month of September. Overall, inflation dropped to 1.5% year over year (from 1.9% previously), falling further below the lower bound of the central bank’s 2%-4% target range. This is the lowest rate since May 2013. Tradable inflation remains the main drag on inflation, with prices posting a zero gain over the last year (from 0.7%), while non-tradable inflation was stable at a comfortable level (3.3%).

While inflation has been low for most of the year, prices departed significantly from historical figures in 3Q17. Affected by the September print, accumulated inflation in the quarter was only 0.3%, compared to the 0.8%-1.6% range for 2010-2015 and 0.5% in 2016. In fact, inflation for a comparable quarter was lower only in 2009 (+0.2%), in the midst of the global financial crisis. Low inflation was mostly due to volatile components (such as food items: 1% in the quarter, far lower than the typical 3%-4%) and tradable-goods prices (0.1%, versus 1%-2.5% in past years).

We see inflation at 1.8% for end of this year. The downward surprise in September inflation and the lagged effect of the prolonged strong performance of the Chilean peso will keep inflation low. Specifically, annual inflation is expected to remain below the 2%-4% target range for the next 11 months, ending next year at 2.8%. Our expectation for higher inflation relies on the assumption that the Chilean peso depreciates close to 4% from spot levels at the end of October, the output gap narrows and that inflation for non-processed food (-11.5% year over year in September) normalizes. Well-behaved inflation expectations will also contribute to lift inflation next year. However, considering inertia, the fact that economic recovery is still incipient and the favorable environment for emerging markets (benefiting copper prices and the Chilean peso), the risks for our 2018 forecast are tilted to the downside. 

More easing a possibility

As widely expected by the market, the central bank of Chile held the policy rate at 2.5% in October. However, building on the downside inflation surprise in September, the press release now includes an easing bias. This means that the probability of additional easing in the short-term has increased, and the likelihood of this event will hinge on incoming inflation prints.

The short-term risks to inflation outlined in the third-quarter Inflation Report (IPoM) have become more likely. The central bank sees inflation below expectations in the short term, which could affect the trajectory to the 3% target over the relevant two-year horizon. Hence, the evolution of inflation will receive special focus and ultimately determine whether a looser monetary policy is required. Meanwhile, the board is content that activity is unfolding as outlined in the IPoM.

Our baseline scenario is for the central bank to leave the policy rate unchanged at 2.5% for the rest of this year and for most of next year, but we cannot rule out additional rate cuts considering the risks for inflation. 

Election time has arrived

The November 19 general election is looming, and the basic scenario remains that a presidential runoff vote (December 17) will be required to determine Michelle Bachelet’s successor. The average of the most recent public opinion surveys shows former president Sebastian Piñera holding a commanding first-round advantage (at 43%). Alejandro Guillier (whose candidacy is supported by the majority of the parties in the ruling coalition) is comfortably in second place at 23%, while Beatriz Sanchez from Frente Amplio is running third with 12%. Election polls cannot be published after November 4, roughly two weeks before the election.

Simulated runoff votes show a tight race. Piñera leads Guillier by an average of 10 pp in the last four weekly Cadem polls and just over 12 pp in the CEP survey, with the latter showing close to one-third of voters undecided. A note of caution when interpreting the survey results: the figures reported are not raw electoral preferences, but rather adjusted for the likelihood that a respondent shows up to the polls. As this is done based on historical voting patterns, there are two layers of statistical error: measurement error and historical bias.


 

João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


 

Please see the attached file for all graphs.



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