CHILE – Monetary Policy Report: Swift stimulus withdrawal as inflationary pressures rise

The policy rate will likely end this year close to (or at) 3.0%

Andrés Pérez & Vittorio Peretti


The Central Bank’s 3Q Monetary Policy Report (IPoM) outlined an economy that risks overheating, justifying a full withdrawal of monetary stimulus. The Board of the Central Bank notes that the Chilean economy has surpassed pre-pandemic levels with the recovery due to adaptability of firms and households to mobility restrictions and a more recent reopening. The recovery has also been supported by significant monetary and fiscal stimuli. However, the expansion and persistence of some stimulus, combined with a high propensity of households to consume, has resulted in private spending exceeding forecasts. In a context in which supply-chains have yet to fully adjust, and the Chilean peso has depreciated amid idiosyncratic risks, expected inflation was revised up. As a result, the Board believes that a faster (and full) withdrawal of the monetary stimulus is required in order to avoid the build-up of macroeconomic imbalances, signaling rates would reach neutral levels (3.25-3.75%) by around mid-1H22, far earlier than outlined in the 2Q IPoM (below neutral until at least June 2023).

Growth revised up this year, but medium-term outlook remains downbeat. The baseline scenario considers that the output gap has already closed and will turn positive in 2H21. The Board expects the economy to grow between 10.5% and 11.5% this year (revised up by 2pp from 2Q IPoM), but to slow down significantly thereafter. GDP growth is seen between 1.5% and 2.5% in 2022 and between 1% and 2% in 2023. The higher range for this year is in response to stronger-than-expected data in 2Q and a significant upward revision of the path for consumption. The Board notes that the propensity to consume – of regular income, IFE and pension withdrawals – is exceeding expectations, which along with the extension of fiscal transfers to year-end will likely result in total consumption growth of 16.9% this year (from 13.8% forecasted in June). In fact, the liquidity injections that households received in the second quarter of this year were higher than last year, and those expected for the second half of 2021, including the extension of the universal IFE, far exceed what was received throughout 2020. Gross fixed investment is seen growing 15.9% this year (+4.5pp from 2Q IPoM), mainly driven by machinery and equipment, in line with the reactivation of projects associated with fewer mobility restrictions. Although a higher level of spending is also anticipated for next year, the higher base of comparison results in an estimated growth range 50-bp lower for 2022 (to 1.5%-2.5%). Total consumption growth is seen slowing to 0.5% in 2022 (1.3% previously) on the back of a higher base of comparison, the extinction of the universal IFE, the depletion of accumulated liquidity due to withdrawals of pension savings and the tighter financial conditions. Investment is seen moderating to 0.3% next year (3.2% in 2Q).  

The strong dynamism of consumption, the idiosyncratic depreciation of the peso, higher international fuel prices and persistent disruptions to supply chains have led to rising short-term inflation expectations. Inflation is now expected to end this year at 5.7% (4.4% in June), remaining above 5% during the first half of 2022. The slowdown in demand generated by the withdrawal of fiscal and monetary stimulus policies will lead inflation to begin its convergence towards the 3% target (3.5% by the end of 2022 and 3% by the end of 2023). Core inflation - CPI without volatile items - was also revised upward, to 4.7% by the end of the year (3.9% previously) and peaking towards the middle of 2022 at 5.5%. In recent months, the peso has lost value against both the dollar and a basket of currencies. The Board reemphasized that passthrough coefficient from the exchange rate to inflation is higher when the movement comes from idiosyncratic shocks to Chile (25%) -such as the current one- versus one related to global factors (5%).

Overall, the Central Bank believes the economy has already overcome the immediate impact of the pandemic on activity, and public policies need to adapt to prevent macroeconomic imbalances. The Board estimates that the convergence of inflation to the target will require the continued withdrawal of monetary stimulus, in line with taking the policy rate to around its neutral value (3.25-3.75%) towards the middle of the first half of 2022.

Risks are shifted towards a contractionary policy stance. In the policy rate corridor delimiting the path for policy rate, the lower limit would be consistent with a scenario of lower inflation if domestic uncertainty (linked to pension withdrawals and fiscal policy consolidation) partially dissipates. The upper limit of the corridor is determined by a scenario of fiscal consolidation postponement requiring a stronger monetary policy response. Importantly, the Board believes the latter is more likely to occur than the former, which could lead to a policy rate trajectory closer to the upper bound of the rate corridor.

In all, the policy rate will likely end this year close to (or at) 3.0%, entering the neutral range estimated by the Central Bank in early 2022 and possibly peaking above the 3.75% upper bound of the range during the first semester. As outlined in the IPoM, a key event to monitor in the near term will be the discussion in Congress on a fourth pension fund withdrawal (to be voted today in the Constitutional Committee of the Lower House). Separately, the fiscal policy path outlined in the 2022 Budget bill, to be sent to Congress by the end of September, will also be critical in terms of outlining potential rate paths.

Andrés Pérez M.
Vittorio Peretti