The minutes of the October meeting show the Board favored a prudent, smaller-than-expected cut due to tighter global financial conditions. The Board evaluated lowering the policy rate by 50bp or 75bp, and unanimously decided to slow the pace again with 50bp to 9% (surprising the market: analyst survey had 73% in favor of a 75bp cut). While the easing cycle was set to continue, the heightened sensitivity of the CLP to several factors warranted further evaluation of the medium-term implications on the inflation convergence, favoring a smaller cut.
All five members agreed that on the domestic front, activity and inflation scenario were broadly in line with the BCCh’s forecasts, although the non-volatile CPI component had fallen somewhat faster than anticipated. Regarding external developments, higher commodity prices and a weaker CLP would have a short-term inflationary effect. However, the Board noted that if tight external financial conditions persisted, the medium-term effects on activity and inflation would be negative.
The Board highlighted that CLP’s recent performance reflected greater sensitivity to news, and showed higher volatility. The Central Bank believes this behavior can be linked to Chile being more advanced in the inflation convergence path, resulting in a priced-in easing cycle that coincided with a more hawkish Fed. This expectation of smaller interest rate differentials were generating uncertainty, reflecting greater risk premium and exchange rate sensitivity. Under these circumstances, the Board felt additional prudence on policy rate moves could contribute to lower short-term financial stress.
Overall, the Board requires more clarity on the evolution of recent macro-financial developments, to improve their understanding on the underlying factors of inflation and its persistence, as well as their potential negative effects on activity. These unfolding events and elevated volatility led the Board to postpone assessing the overall balance of these impacts. In this context, and with inflation not having completed its convergence process, the easing cycle needed to continue but at a somewhat slower pace.
The BCCh insists it does not target the level of the CLP. While the minutes do not include a discussion on the decision to suspend the reserve accumulation program nor pause the unwinding of the NDF program, they do include a final paragraph in which the Board reaffirms its inflation target and the monetary policy rate as the main instrument to achieve its objective, insisting they do not target a level of the CLP.
We believe tighter global financial conditions, the currency’s elevated sensitivity to narrowing interest rate differentials, and the latter’s implications for the disinflation path will lead the BCCh to adopt a more gradual easing cycle. We expect the BCCh to cut the policy rate by 50 bps in December, for a year-end rate of 8.5%, and we project a gradual downward path in 2024, with the rate reaching 5.75% by December 2024. However, with the real one-year ex-ante rate at 5.7%, well above the BCCh’s neutral rate range (0.5 - 1.0%), falling inflation, anchored inflation expectations, and a weak activity outlook, the BCCh’s total budget of cuts in the easing cycle could be greater, in turn, placing a depreciation pressure on the currency. The December IPoM (to be published on December 20), will bring more information as to how the Board evaluates the short and medium-term impact of recent global developments on the inflation path and the appropriate rate cut path required ahead.