Itaú BBA - CHILE – Monetary Policy Meeting: Dovish tone points to September cut

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CHILE – Monetary Policy Meeting: Dovish tone points to September cut

julio 19, 2019

July’s decision is in line with our expectation of lower rates (at 2%) by yearend.

Following the surprise 50-bp rate cut last month, the board of the Chilean central bank opted to hold the policy rate at 2.5%, in line with market expectations. However, the decision was not unanimous, with Pablo Garcia voting for a 25-bp rate cut. It was the first split decision since August 2017, when the same board member voted to continue with rate cuts after the central bank had implemented a 100-bp cycle to 2.5%. Meanwhile, the press release announcing the decision moved from a neutral tone to a dovish bias. The board states that since the 2Q19 Inflation Report (released on June 10), risks to the convergence of inflation to the target have increased. Particularly, it highlighted the slowdown of inflation measures closely reflecting economic slack and the growth recovery risk given the uncertain global context. The board noted that if these tendencies persist, additional monetary stimulus would be required.

On the external front, the report highlighted the move by global central banks to adopt a looser monetary policy approach as inflation pressures stay low and global growth concerns persist. As a result, long-term interest rates dropped, boosting stock markets and increasing capital flows to riskier emerging markets, which led to a global weakening of the U.S. dollar. Commodity prices posted contained gains since the last meeting.

The board notes the surprising, and widespread, deceleration of service inflation (closely related to the output gap and labor costs). Moreover, it indicated the upside surprise of the traditional core inflation gauge (excluding food and energy) was due to the exchange rate sensitive tourism package component. Meanwhile, the press release stated that short-term inflation expectations have dropped and traders’ two-year inflation expectations sit at 2.8% (3% target).

Activity in 2Q19 showed weaker-than-expected dynamism, while downside risks to the growth scenario have risen. The board notes that part of the weakness is due to mining and other transitory shocks, but slowing imports of consumer goods and the significant deterioration of consumer confidence highlight a more widespread concern. On the investment front, countering some favorable developments related to the service sector are the weaker purchases of construction materials and low business confidence. Finally, shrinking exports reflect softening global demand.

Since last month’s decision, market expectations changed to include more easing. According to the results of the central bank’s trader survey following the June rate cut meeting, lower expected inflationary pressures supported a call for further easing (25-bp cut in October to 2.25%), with stable rates thereafter for at least a year. Despite the median results showing only one rate cut, it is worth noting that around 35% of respondents see the policy rate at 2.0% (2 x 25-bp cuts) before July next year. In addition, the monthly survey of analysts showed that lower inflation in the short-term, along with weaker growth, led to the expectation of a rate cut in October or December to 2.25%, with rates stable thereafter until at least June 2020. Nearly 30% of respondents saw the policy rate at 2% by yearend (10% in the prior survey).

We expect the policy rate to reach 2.0% by yearend, with the next cut likely in September. Global uncertainty, weak private sentiment and contained copper prices would limit the activity recovery in 2H19. Hence, we believe the output gap would not narrow in line with the central bank’s 2Q19 baseline scenario, keeping inflationary pressures contained and providing room for additional stimulus.

Miguel Ricaurte
Vittorio Peretti

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