CHILE – The start of a gradual normalization cycle

Enhanced fiscal impulse supports increasing rates.

Vittorio Peretti 


As expected, the board of the central bank of Chile started withdrawing some of the monetary impulse at its July meeting with a 25bp hike to 0.75% (ending the period of stable rates at the technical floor of 0.5% reached in March last year at the onset of the pandemic). The decision was unanimous. The communique built on the message laid out in the 2Q Monetary Policy Report and the minutes of the June monetary policy meeting explaining that the increased fiscal expansion and consumption dynamism have shaped a macroeconomic scenario for the next two years in which the highly expansionary monetary-policy stance was no longer necessary. High growth momentum brought forward the expected timing of the output gap closure (compared to the March scenario). Nevertheless, the board reaffirmed its expectation of a gradual withdrawal process, as it looks to support the recovery of lagging sectors, consolidating the signaling that the policy rate will likely be below its neutral value (3.5%) throughout the two-year policy horizon.

On the global front, the recovery path is consolidating particularly in countries that have advanced vaccine rollouts, allowing for the reopening of their economies. Emerging economies are still lagging, while the spread of new strains of Covid-19 is a new risk factor. In financial markets, the dollar has appreciated against other currencies and stock markets have had mixed results, all within a context of persistent cost pressures. The board notes that some monetary authorities, particularly the Fed, continue to view these pressures as transitory, mitigating concerns about the recent rises in inflation. Meanwhile, several central banks (particularly linked to commodity exporting economies) have initiated the process of withdrawing monetary stimulus.

Domestically, activity in May exceeded expectations to the upside (+18.1% YoY), returning activity to pre-pandemic levels. Activity dynamism is led by consumption (on the back of pension withdrawals), and is set to be further aided by the augmented fiscal transfers (during 3Q21). While the board notes that total employment is still far from pre-pandemic levels, administrative records reveal a recovery of formal salaried employment, while job vacancies and wage growth are increasing.

Central bank surveys show that inflation expectations of financial operators and analysts remain anchored to the 3% target over the medium-term. The board highlights that fuel prices have been the key driving factor behind the recent inflation increase (to 3.8%), while food price pressures have eased. Meanwhile core inflation (excluding volatile prices) is lower and near the 3% target.

We believe, the significant activity rebound underway, along with the increased fiscal aid and higher inflationary pressures, justified the start of removing stimulus. The sharp fall in COVID-19 cases has allowed the government to loosen mobility and business operating restrictions in July that, along with the swift advancement of the vaccination program, would consolidate the economic recovery during 2H21 (Itaú: 8.5% for 2021). Less than 5% of the population is currently under the strictest quarantine measure, compared to around 50% a month ago, while over 75% of the adult population is fully vaccinated, and the program has also recently been extended to minors (12-17). Overall, we expect 25bp hikes in the remaining meetings of the year, taking the policy rate to 1.5% by yearend. For next year we expect the rate to reach 2.5%, as the board will likely retain an expansionary stance to prop up the recovery of lagging sectors.

Joao Pedro Resende
Vittorio Peretti