Itaú BBA - CHILE – Monetary Policy Meeting: A 50-bp rate cut and “low for long” forward guidance

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CHILE – Monetary Policy Meeting: A 50-bp rate cut and “low for long” forward guidance

Março 31, 2020

Any additional monetary stimulus would likely come through quantitative easing measures

The central bank of Chile cut its policy rate by a further 50 basis points to 0.5%, in line with our forecast and market expectations. The decision had the unanimous backing of the board and results in a 125bp rate adjustment over the last two weeks. The board signaled that, given the nature of the shock (lowering both inflation and growth expectations), the policy rate is expected to remain at this significantly expansionary level for an extensive period. Additionally, the board doubled its bank bond-buying program to USD 8.0 billion (totaling close to 3% of GDP). The combination of the announced monetary stimulus and fiscal package (4.7% of GDP) would help avoid permanent damage to the economy that could lead to a sharp unemployment rise and credit events.

Besides the forward guidance, there is another hint in the statement that additional cuts are unlikely. This comes from the board’s statement that the rate has reached its “technical minimum”, a description utilized during the global financial crisis when the easing cycle ended at 0.5%. Back in June 2009, the board intensely debated on the minimum level for the monetary policy rate. At that time, members came to the agreement that rates at 0.5% or higher allowed for the correct functioning of all sub-sectors of the financial market, particularly corporate mutual funds on whom several banks relied on for funding, whose administration fees hovered around 0.5%.

The board notes the significant deterioration of the external scenario as the spread of the coronavirus disrupts both demand and supply chains. The additional uncertainty about the magnitude of the economic impact of the pandemic has fueled a substantial increase in risk aversion in the markets. This has been reflected in a high demand for safe and short-term assets, a surge of volatility, widespread falls in stock markets, capital outflows from emerging economies, cross-currency depreciation against the U.S. dollar and a sharp decline in commodity prices, including copper. The evolvement of the Chilean financial market was in line with these developments and led to the announcement earlier this month of measures to facilitate the normal flow of credit and the proper functioning of the markets.

Although Chilean activity data is yet to reflect the impacts of the global shock, a severe contraction is expected to unfold in the latter part of March and extend into 2Q20. While activity indicators for January and February reflected a faster-than-expected recovery, the COVID-19 shock abruptly alters the outlook for the remainder of the year. The board noted that market expectations point to an activity contraction.

Despite annual inflation sitting near 4% as of February (3% target, with a tolerance range of 2%-4%), the coronavirus outbreak significantly reduces medium-term inflationary pressures, given the expected widening of the output gap. Additionally, plummeting oil prices counters increased cost pressures from the weakened CLP. The board notes that although the one-year inflation expectation has fallen sharply, the relevant two-year outlook remains anchored at the 3% target.

On Wednesday morning (April 01), the central bank publishes its flagship IPoM where it will likely reinforce the guidance of stable rates at the current level. A downgrade to a -1.0 to -2.0% growth range is likely, while medium-term inflation expectations could be lowered to below the 3% target.

While we expect rates to stay at this historically low level for the remainder of the year, we cannot rule out additional monetary stimulus if risks for the economy increase even further. However, quantitative easing measures are significantly more likely than additional rate moves.


 

Miguel Ricaurte
Vittorio Peretti



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