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Accelerating the pace to 75bps.
2023/12/15 | Andrés Pérez M., Vittorio Peretti & Ignacio Martinez Labra

There are several arguments leading into this month’s monetary policy meeting that favor stepping the rate-cut pace back to 75-bp from the 50-bp cut in October, taking the yearend nominal rate to 8.25%. The central bank’s rate-cut cycle has seen the magnitude of cuts swing from a 100-bp start in July from 11.25%, to 75-bp in September, and the most recent 50bp to 9%. First of all, global financial conditions, cited as a key factor in the precautionary step down to 50-bp in October, have improved materially. Second, we estimate that cumulative core inflation since the September IPoM has surprised the BCCh to the downside for the full year by roughly 50bps, on average, while inflation expectations remain well anchored. Third, domestic activity has been essentially in line and the positive output gap likely closed this quarter. In this context, the real ex-ante one-year real rate stands at 5.9% substantially above the BCCh’s real neutral rate estimate of 0.5-1.0% (to be revised in this month’s IPoM, see below), suggesting that the policy rate is still too contractionary for the stage of the cycle. As such, the combination of domestic developments and a loosening of global financial conditions paint a macro scenario that resembles the September IPoM, when Board guidance showed a preference for a 2023 year-end rate of around 8% (implying 75-bp cuts on average in the October and December meetings). In this context we feel the window of opportunity is open, and the Board will step back to a 75bp cut and end the year at 8.25%.


Relief from the global backdrop. The sharp fall in U.S. Treasury yields has been the main development in global markets in recent weeks (by around 90 bps since the October monetary policy meeting), which, put together with the suspension of the BCCh’s reserve accumulation program, has contributed to the CLP’s outperformance (6.5% appreciation since the previous MP decision). The latter, along with the decline in global oil prices (down 12% since end-October) consolidate the disinflation process. In line with lower inflationary pressures, medium-term inflation expectations from breakevens that dropped below the 3% target, while survey-based inflation expectations remain anchored at the 3% target.


Domestically, activity dynamics have been volatile, but the overall trend broadly supports the BCCh’s view that activity has bottomed out and should improve sequentially. The economy expanded sequentially by 0.3% qoq/SA in 3Q23 (-0.3% in 2Q23), pulled up by net exports (+1.6 pp contribution) and total consumption (+0.7 pp), while lower inventories (-1.4 pp) and falling gross fixed investment (-0.6 pp) were key drags in the quarter. The positive net exports contribution was driven by falling imports and higher exports. In annual terms, the economy grew 0.6% in 3Q23, up from -0.8% in 2Q23. At the start of 4Q23, the monthly GDP proxy (IMACEC) rose 0.3% over one year, but non-mining activity grew somewhat faster (1%). While falling interest rates and inflation are supporting a stabilization of real consumption, downbeat business sentiment is reflected in persistently weak investment in construction.



Focus on lower core inflation, despite upside surprises in headline. Since the October 26 monetary policy meeting, two inflation prints have been released, in which we estimate core inflation has surprised the BCCh to the downside for the full year by roughly 50bps, on average. The BCCh is likely to see through the large upside surprise to headline inflation in November, as it was largely driven by volatile items (including an 18% monthly increase in air tickets in November). Total inflation fell 20 bps from October to 4.8%, and core inflation declined to 6.0% (from 6.5%). Total inflation is likely to end the year somewhat above the BCCh’s 4.3% call, again, driven by recent upside surprises in volatile items.


Marginal changes in the corridor. The IPoM, also to be released this week, should include a corridor that is not materially different to September, with a 5.4% average for 4Q24 seen in the 3Q23 IPoM, likely with a slightly higher terminal rate driven by our expectation of an upward adjustment to the neutral rate. Sensitivity scenarios are likely to include risks tilted towards a swifter cycle depending on how the central bank assesses the Fed’s cycle.


Updated structural parameters, with risks tilted to lower trend growth and a slightly higher neutral rate. In line with its annual review process, the BCCh is expected to update its structural parameters in the December IPoM. Fewer hours worked, declining productivity, and uncertainty denting investment dynamics may lead to a further reduction in the BCCh’s non-mining trend growth. The 4Q22 update showed a 2023-2032 average of 2.2% (-50 bps from the prior update in 2Q21). The BCCh’s real neutral rate estimate rose by 25 bps in December 2022 to a range of 0.5% to 1%, centered at 0.75%, leading to a nominal neutral rate centered at 3.75%. Our neutral rate estimates (based on interest rate parity, asset prices, and a Laubach-Williams semi-structural model) suggest neutral rates have been somewhat above the upper bound of the BCCh’s estimate for some time, pointing to room for an increase in the neutral rate range by between 25-50 bps. Another increase in neutral rate estimates in Chile would be in line with revisions by other central banks in the region in recent months including Brazil (+50 bps to 4.5% in June), Colombia (+20 bps to 2.4% in October), Peru (+50 bps to 2% in September), and Uruguay (+30 bps to 2.4% in November).

The improvement in global financial conditions allow for a larger rate cut next week. Market expectations are mixed on the size of next week’s cut. BCCh’s surveys finalized prior to the latest Fed shift in guidance show a larger share of the BCCh’s analyst survey (48%) expects a 50-bp cut, while 38% expect a 75-bp reduction, while traders expect a similar distribution of cuts. Asset prices as of December 14 priced in a 68-bp reduction. Overall, macro conditions better resemble the September meeting than October, permitting the Board to step back to the 75-bp pace at this meeting. We believe an acceleration to 100bp is a stretch too far, as the Board may still be weary of the market reaction post the prior decision of such magnitude.