CHILE – Monetary Policy meeting Minutes: Reaffirming a gradual stimulus withdrawal

Medium-term risks and current uncertainty support a cautious approach

Vittorio Peretti 

30/07/2021


The minutes of the July monetary policy meeting show all board members agreed that a 25bp rate hike (to 0.75%) was a sufficiently robust response to the varying scenarios analyzed for the economy, playing down the more aggressive rate trajectory internalized in market prices. The 25bp hike was deemed appropriate for an economy recovering at a faster pace than anticipated earlier this year, but also with lower growth expectations for the medium term. The board evaluated keeping rates on hold, but ruled out that option on the lower probability of less favorable scenarios materializing for the economy (likely due to the advancing vaccination program and economic reopening process). Overall, the board continued to communicate that in order to ensure the convergence of inflation to the target, monetary stimulus would continue to be required going forward (albeit less than the current intensity) as weakness remained in some sectors, uncertainty is still high, and a notable fiscal consolidation is anticipated during 2022.

The board judged the evolvement of both the external and local scenarios to be broadly in line with expectations outlined in the 2Q IPoM, with the vaccination progress in key economies standing out, allowing for the consolidation of the economic recovery. Another key development was the inflation concern, especially in the US, but the view prevails that it is a transitory phenomenon. While global financial markets continued to be very constructive, there seemed to be a gradual deterioration for Latin America, including Chile.  

Domestically, activity surprised once more to the upside, boosted by dynamic consumption, but investment remained sluggish and there was concern for its future performance. In the Central Bank’s Credit Survey for the second quarter, lower demand by companies for both working capital and investment was highlighted, partly due to a sense of a deteriorating economic environment or greater debtor risk. This was complemented by information gathered for the Business Perception Report, which revealed that most of the firms interviewed had not requested new loans due to improved cash flows or out of caution given the various sources of uncertainty. Inflation, in turn, was somewhat lower than expected. The mixed labor market signals were also highlighted, with surveys showing lags in the employment recovery, a significant loss in labor participation and high unemployment. On the other hand, according to administrative data (contributions to pension funds), formal salaried employment had made a complete recovery, there was an increase in vacancies and the wage bill had improved. The board felt that people remained cautious about taking a job, particularly non-salaried, because of COVID-19 infection risk (which has since fallen), challenges for women given school restrictions at the time (most schools are now reopened), as well as the presence of the income transfer program for families (active through to September). The board also focused on the persistent uncertainty present in Chile and its effect on the financial market. It was highlighted that the decoupling from external markets continued, with long-term interest rates showing greater volatility, an exchange rate that was partially more depreciated than could be justified by the copper price and the global behavior of the dollar, and a stock market that continued to lag behind the global benchmarks. Overall, however, the general assessment was that these developments had not translated into tighter local financial conditions.

In this context, all board members agreed that medium-term risks and the need to better understand the state of the labor market and the evolution of credit, made it suitable to follow a gradual monetary policy adjustment.

We expect the policy rate to reach 1.5% by year-end, with 25bp rate hikes during the final three meetings, and 2.5% by the close of 2022. Nevertheless, despite the board communicating that a gradual policy normalization will unfold, pressure on the government to extend the income transfer program for an additional three months to yearend, along with the Congress evaluating a fourth 10% pension withdrawal could, on materialization, could lead to a swifter withdrawal of stimulus ahead.

Vittorio Peretti