Itaú BBA - CHILE - Monetary Policy Meeting: Surprising 50bp rate cut

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CHILE - Monetary Policy Meeting: Surprising 50bp rate cut

junio 7, 2019

Although the central bank does not signal further rate cuts, we see room for an additional 50bps of easing to 2%.

The central bank unanimously decided to cut the policy rate by 50bps to 2.5%, surprising all Bloomberg market participants (consensus of stable rates). The communication signals no more easing is expected in its updated baseline scenario. This is largest rate cut since the global financial crisis, as the board likely front-loads in anticipation of a global growth slowdown amid heightened protectionist policies. The scenario of additional easing had become probable, as signs were that the output gap was wider than expected, inflation remains low and controlled, and the global economy is set to slow. However, the fact that the the board did not wait until Monday’s Inflation Report (IPoM) to change the rate guidance and lay out the conditions that warranted rate cuts was surprising.

It is worthwhile to recall that the guidance included in the 1Q IPoM (released just over two months ago) was for stable rates for at least two quarters (4Q19), before the resumption of the gradual normalization process. Since its publication, the board communication hinted at a change in view, with the appetite for rate cuts increasing gradually.

Justifying the additional easing were changes to structural parameters. The neutral rate was lowered by 25bps (from 4%-4.5% previously), partly reflecting the decline in international rates. This change meant that monetary policy was not as expansionary as previously thought. Meanwhile, the central bank concluded that the influx of immigrants raises both the short-term (2019-2021) growth potential to 3.4% (from 3.2% forecasted in 3Q18), while the medium-term forecast range was increased by 25bps to 3.25%-3.75%. Hence, with higher potential and underwhelming growth in 1Q19, the negative output gap is wider than expected, a condition also warranting more monetary stimulus.

The communication notes that fears of the growing trade tensions have led to lower global growth expectations, correction of stock markets, falling long-term market interest rates, lower commodity prices and an appreciation of the US dollar.

The board expects clear evidence that inflation would converge to 3% to trigger a normalization cycle. The board added that how the labor market absorbs immigration flows, the evolvement of investment and the evolution of the external scenario would be key factors behind evaluating whether the inflation convergence is consolidating. We note that despite the upside surprise to inflation in May, core measures and our diffusion index point to low inflationary pressures. 

Although the central bank does not signal further rate cuts, we see room for an additional 50bps of easing to 2%. 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. Hence, the output gap would widen further than the board is currently estimating and motivate additional action. 

Miguel Ricaurte
Vittorio Peretti

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