CHILE – Monetary Policy Meeting: A unanimous 125bp hike to 2.75%

Another hawkish surprise from the Central Bank of Chile

Andrés Pérez & Vittorio Peretti

13/10/2021


In a second consecutive surprise to the market, all Board members agreed to hike rates by 125bps to 2.75%, 25bps more than the Bloomberg market consensus (and Itaú) and 50bps more than the analyst expectation from the Central Bank’s survey released earlier today. With two-year ahead inflation expectations moving further beyond the 3% target (trader survey: 3.5%; analysts survey: 3.3%), amid domestically driven exchange rate depreciation and robust consumption, the Board opted for a swifter withdrawal of stimulus than outlined in the September Inflation Report (IPoM), signaling that the policy rate will reach its neutral level (3.25-3.75%) sooner than the mid-1H22 incorporated in the IPoM’s central scenario. The Central Bank also suggests a possible revision to the end point of the cycle (around 4.5% for the upper bound of the 33% confidence interval) will be communicated in the December IPoM, taking consideration of the need to prevent a more persistent increase in inflation that results in a persistent de-anchoring of medium-term inflation expectations. Additionally, the Board agreed to suspend the reserve accumulation program initiated last January, by virtue of the recent evolution of the financial market and the level of international reserves already reached (USD 53 billion in September, from USD 39 billion at the close of 2020).

Since the last meeting, a less supportive external environment has unfolded while domestic factors hinder the local financial market. The constraints associated with new Covid-19 outbreaks and pursuing bottlenecks have hampered the global growth outlook, while global inflation has been rising. Overall, several Central Banks have signaled or already acted on withdrawing monetary stimulus, while global financial markets have reduced risk appetite, leading to rising interest rates, a strengthening of the global dollar, and mixed stock market developments. The Central Bank acknowledges that the local financial market has deteriorated, with movements at the extreme of international developments. The changing inflation outlook and growing political and legislative uncertainty (fourth pension withdrawal), are key reason reasons behind the dynamics in the local capital market. The 10-year nominal interest rate has reached 6.5%, the highest in over a decade, with the difference between the equivalent US note increasing by 130bps to 500bps in just over the last month. During the same period, the CLP depreciated a further 5% relative to the dollar, while the stock exchange fell by around 8% and the country risk (CDS) increased by some 25bps.

Activity remains upbeat, with the rebound of investment-related items reflecting a more widespread recovery underway. In the labor market, the employment recovery is gaining steam at the margin, but there remains a mismatch between labor supply and demand, mainly among the less skilled, which is leading to wage increases. As for bank credit, consumer and commercial loans reduced their annual contraction rates in real terms, while the flow of mortgage loans has remained fairly stable.

The core inflation print in September of 4.2% came in close to the Central Bank’s estimate from the 3Q IPoM, but inflation expectations are rising. Recent price dynamics indicate inflationary pressures on both the demand and the supply side, along with significant pass-through from the CLP depreciation. In this context, the Central Bank notes that inflation expectations in the market have risen for all horizons, with some short-term expectations exceeding the Board’s forecast from September. The two-year inflation outlook, from analyst and trader surveys, has risen and remains above the 3% target.

The Central Bank also suspended their reserve accumulation program initiated last January as a result of the recent evolution of the financial market and greater reserves. Reserves have increased from USD39 billion at the close of 2020 to USD53 billion in September, which we estimate roughly USD3 billion short of their original 18% of GDP target. It is important to note that the reserve accumulation program was implemented as part of an exit strategy from the IMF Flexible Credit Line that expires in May, 2022. While the increase in the Bank’s reserves are a welcome development that enhances its ability to withstand external shocks, the Government’s Stabilization Fund has been pretty much depleted, and the perception of external vulnerability of the Chilean economy has increased materially. As such, we believe the Bank is likely to reassess its exit from the FCL facility.

We see a further 125bp rate hike to 4.0% at the December meeting, with the cycle pausing during 1H22 at 5.5%. The tone of the communiqué is surprisingly hawkish, which suggests the Board must have also considered an option of a 150bp hike, which we should have further clarity once the meeting minutes are published (October 28). A key element to monitor will be the reaction of two-year ahead inflation expectations; if these fail to return to the 3% target, the Bank is likely to surprise again in future meetings. Amid rising risks to greater inflation ahead, and signs that further stimulus may be approved (fourth pension withdrawal), we expect the Central Bank to continue to counterbalance the level of stimulus in the market. With the estimate of a growing positive output gap, and additional idiosyncratic CLP depreciation that leads to larger and more persistent FX pass-through to local prices (affecting inflation expectations), we expect the Board to aggressively move towards a contractionary monetary policy.

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Andrés Pérez M.
Vittorio Peretti