Itaú BBA - CHILE – Inflation Report: Only a 50-basis point cycle?

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CHILE – Inflation Report: Only a 50-basis point cycle?

junio 10, 2019

With growth risks that are seen tilted to the downside, the central bank left the door open for additional easing.

After Friday's unexpected rate cut (June 07), the central bank of Chile released its quarterly Inflation Report (IPoM), providing additional details on the reasoning behind the move. Elements justifying the largest rate cut in a decade (the previous time BCCh cut rates by 50bps was back in June 2009) include the activity outlook downgrade (sluggish start to the year), higher short-term potential and long-term trend growth (due to immigration flows), and the lowering of estimated neutral rate (partly reflecting global rates). The board’s working assumption going forward is for stable rates for the following quarters, before starting a gradual normalization process next year.

In updating the structural parameters, the board had sufficient justification to lower the policy rate. The influx of immigrants raised the short-term (2019-2021) potential growth, to 3.4% (from 3.2% forecasted in 3Q18), while the estimated range for medium-term trend growth was increased by 25bps to 3.25%-3.75%. According to the latest estimates and projections of population published by the National Statistics Agency (INE), between the end of 2014 and the end of 2018 the immigrant population in Chile grew from almost 490 thousand people to more than 1.25 million. This implied an increase in population and labor force of close to 4.3% and 6.4%, respectively. A second boost to potential comes from the educational level of the average immigrant. Immigration over the last 18 months (approximately 470 thousand people) has been dominated by Venezuelan citizens (43%), whose average schooling (15.6 years) exceeds that of the average Chilean (11 years). Hence, with higher potential growth and underwhelming activity in 1Q19, the negative output gap is wider than previously expected, a condition warranting more monetary stimulus. While we see merit in the upward revision of short-term potential growth, there are, in our view risks to the medium-term revision. First, it is unclear that this influx of migrants is permanent, as a reversal could occur were the situation to improve in Venezuela. Second, it is likely that the skills of the inflow of immigrants ahead are lower than that of recent immigrants.   

Additionally, the neutral rate range was lowered by 25bps (to 3.75%-4.25%). This reflects the fall in the neutral interest rates of developed economies (following the global financial crisis), and is only partly compensated by greater potential growth (due to immigration). So monetary policy was not as expansionary as previously thought.

On the external front, the report highlighted the negative developments from the intensification of the trade conflict (greater risk aversion that provoked a global appreciation of the US dollar and a drop in most commodity prices). The board noted that although projections of global growth are broadly unchanged with respect to the 1Q19 IPoM, there was a marked deterioration in the expected world trade growth. The lower copper price forecasts (USD 2.8/lb on average for this year vs. USD 2.9/lb in March) affects Chile’s terms of trade, reducing the external impulse. Meanwhile, the board sees the real exchange rate near the average of the last 15 and 20 years over the next two years.

For the first time since December 2015, growth risks are seen tilted to the downside. Behind the growth revision for 2019 (from 3%-4% to 2.75%-3.5%) was an investment forecast downgrade (from 6% to 4.5%). The deterioration of the external scenario led to the lowering of export growth to 0.6% (from 3.6%). Total consumption was also revised from 3.3% to 3.1%, but the board notes that no major trend change versus previous quarters was witnessed for consumption and highlighted the acceleration of job creation. The 3%-4% expected growth range for 2020 was maintained. The expected recovery is partly due to the effects of strong immigration on waged employment, investment and consumption. 

On the inflation front, the yearend estimate was revised up by 0.2pp to 2.8% (3% target). Risks are balanced. The core measure is seen ending 2019 at 2.6% (2.4% previously). Somewhat lower inflation for next year is expected (core and headline down 0.1pp to 2.9%). Headline inflation would oscillate around the 3% target in 2020, while the core measure reaches the target in early 2021. A gradual closing of the output gap is behind this assumption.

In our view, the effects of an unresolved trade war on Chile could be larger than that outlined in the central bank’s new scenario, supporting our call for further stimulus. A prolonged period of uncertainty would likely result in a sharper investment and export slowdown, resulting in further widening of the output gap that motivates the board to cut rates by an additional 50bp to ensure inflation converges to the 3% target in the relevant two-year forecast horizon.


Miguel Ricaurte
Vittorio Peretti

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