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The core inflation convergence is unfolding more swiftly.
2023/12/20 | Andrés Pérez M., Vittorio Peretti & Ignacio Martinez Labra

The 4Q23 IPoM signals that demand side inflationary pressures are contained and that the convergence of core inflation towards the target is unfolding faster than anticipated, consolidating the view that rates need to be less restrictive to avoid policy overtightening. Since starting the easing cycle in July 2023, the BCCh has cut by a total of 300bps in four meetings. Inflation has fallen from a 14.1% peak in August 2022 to 4.8% in November 2023, gradually inching closer to the BCCh’s 3% target. Medium-term survey-based inflation expectations have been anchored for several months. The ex-ante one-year real rate now sits at 5.15% (still well above the new 1.5% ceiling of the BCCh’s neutral range; down from 5.6% in October). The central bank signals rate cuts will continue with the size being data-dependent.


The positive output gap is estimated to have closed, and is expected to remain close to that level throughout the forecast horizon. Domestic demand is expected to return to positive annual growth during 2024. The outlook for private consumption is adjusted marginally upwards over the next two years, estimating an expansion of 2.1% in 2024 (1.7% in 3Q23) and 1.8% in 2025. Growth in labor income plays an important role in the upward revision, reflecting that the real wage bill has been supported by lower inflation. Gross fixed investment is broadly in line with the previous report (0% in 2024 and 2.4% 2025), with the recovery (-1.9% in 2023) boosted by works related to the mining and energy sectors. Overall, the economy is still seen growing at a range centered at 1.75% next year (0% in 2023) and 2.5% in 2025. The IPoM’s scenario estimates that the Chilean economy will be favored by higher growth in its trading partners, which will average 3.1% between 2023 and 2024 (2.7% in 3Q23), explained by the improved outlook for the US and the greater boost of fiscal measures in China. Furthermore, the expected copper price for the next two years is projected to remain around US$3.8 per pound.


The core inflation convergence is unfolding more swiftly. The baseline still considers headline inflation converging to the target in the second half of 2024. However, the core measure will reach 3% (1H24) ahead of the trajectory expected in September-23 (1H25), responding mainly to the evolution of core goods prices to date. This, in a context where the transfer of costs to final prices has been limited by subdued consumption. In turn, the estimate incorporates a limited passthrough of prior CLP depreciation. The real exchange rate (RER) is seen staying around current levels over the next two years. The BCCh forecasts core inflation ending 2023 at 5.8% (-50bps from the September scenario), and to average 3.5% in 2024 (-30bps).


With the output gap closed, inflation converging to the target and anchored inflation expectations, the central bank sees rates needing to go lower. The magnitude and timing of rate cuts will take into account the evolution of the macroeconomic scenario and its implications for the trajectory of inflation. The center of the 33% confidence interval in the rate corridor signals an average policy rate of 5.3% in 4Q24 (5.4% in September), broadly consistent with a yearend rate of 5% (8.25% currently). In terms of sensitivity scenarios, the upper bound of the corridor is defined by situations in which inflation convergence takes longer. This would be the case if the Chilean economy received a greater than expected external boost. Meanwhile, the lower bound would materialize if the effect of higher long-term rates on the domestic demand dynamics lead to an even swifter inflation fall. Regarding risks, the report explains that the evolution of the external scenario continues to be subject to significant sources of uncertainty, including the fragility of the real estate sector in China, doubts about the fiscal situation in the US and a more complex geopolitical environment.


The central bank updated its structural parameters, lowering trend growth and revising to a higher neutral rate. A slower recovery of labor participation, low productivity growth led to a further reduction in the BCCh’s non-mining trend growth, as we had anticipated. The update showed a 2024-2033 average of 1.9% (2.2% estimated in 4Q22). Of note, the Ministry of Finance’s Committee of Experts for Non-Mining Trend GDP also revised their long-term estimate down to 2% earlier this year, from 2.3%. As we expected, the BCCh’s real neutral rate estimate rose by 25 bps to 1%, with the range expanding to 0.5% to 1.5% (0.5 to 1.0% previously), leading to a nominal neutral rate centered at 4%. The increase in neutral rate estimates in Chile are 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). 


We expect the Board to continue easing and cut rates by as much as possible in the coming months, conditional on financial conditions, including another 75-bps cut in January. We see a 2024 yearend rate of 5%. The next Monetary Policy Meeting will be on the final day of January.