CHILE – Monetary Policy Meeting – Central Bank hikes the policy rate by 75-bps

A more front-loaded rate response allows the Central Bank to reaffirm its commitment with price stability.

Andrés Pérez & Vittorio Peretti

31/08/2021


In a unanimous decision, the Central Bank’s Board agreed to accelerate the pace of the monetary normalization process by implementing a 75bp hike to 1.50%. The market consensus and our call was for a 50bp hike. In July, the Board increased the policy rate by 25bp from the technical minimum 0.5% to 0.75%, and played down the more aggressive rate trajectory implied in market prices. Nevertheless, in today’s policy meeting press release, the Board notes that faster-than-anticipated growth, led by strong consumption, practically closed the negative output gap in 2Q21, which is likely to turn positive in the near term, increasing pressures on consumer prices. In addition, the Board cites other factors that place additional pressure on inflation, such as the weaker exchange rate pass-through of the idiosyncratic depreciation of the peso, ongoing global supply chain disruptions, and fuel price increases. As a result, the Board believes the current response was required to avoid the accumulation of macroeconomic imbalances that, among other consequences, could cause a more persistent increase in inflation beyond the 3% target over the two-year policy horizon. Importantly, the central bank removed from the statement references to a reference rate below neutral throughout the policy horizon.

On the external front, a sustained recovery remains the base case, although momentum has slowed in the major economies amid the spread of the COVID-19 delta variant. For emerging economies, a lagging vaccination process means the outlook is less auspicious. Even so, with inflationary pressures on the rise, several central banks are withdrawing monetary stimulus. International financial markets remain supportive.

Domestically, the performance of financial markets continues to be largely dominated by idiosyncratic factors, such as a potential fourth partial pension withdrawal, currently being discussed in Congress. Fixed income interest rates continued to register increases, particularly in the short-part of the nominal curve. The 10-year rates also rose, widening the gap with their external peers. This contrasts with the significant drop in shorter-term UF yields, linked to higher inflation expectations. On the credit front, the increase in long-term interest rates is already being reflected in the mortgage market.

The GDP increase of 18.1% YoY in 2Q21 exceeded the Central Bank’s estimates, amid extraordinary private consumption dynamism, suggesting the influx of liquidity (pension withdrawals and fiscal transfers) is having a stronger effect on activity. This trend continued in July. The recent extension of universal fiscal transfers (of around 2% of GDP) to households implies an even greater fiscal impulse than that incorporated in the June Monetary Policy Report (IPoM; 2021 GDP growth estimate of 8.5-9.5%). Investment has also surprised the Board to the upside. Meanwhile, recent labor market data showed employment gains across categories and job-openings continue to rise, consistent with increasing wage pressures. With an upside inflation surprise in July, the Board notes that short-term inflation expectations have risen. Meanwhile, it outlines that analysts’ two-year outlook remains anchored at 3%, but financial operators forecasts sit at 3.5%.  

In this context, we believe a more front-loaded rate response allows the Central Bank to reaffirm its commitment with price stability. On Wednesday, the Central Bank will publish its flagship quarterly report (IPoM), likely providing a clearer guidance for policy rate. We expect a hawkish stance, signaling a swift return to the neutral rate during 2022 (compared to the previous stance of keeping rates expansionary at least until June 2023).

Andrés Pérez M.
Vittorio Peretti