Itaú BBA - Monetary easing about to begin

Scenario Review - Chile

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Monetary easing about to begin

Janeiro 19, 2017

We expect a 100bps loosening cycle this year.

Please see the attached file for all graphs.

• In 2018, Chile will have posted five consecutive years of low growth, following the end of the commodities boom cycle and subdued private sentiment.

• A more stable currency has led to faster-than-expected disinflation. The inflation index will move towards the bottom of the 2%-4% target range this year, before returning to the 3% target in 2018.

• The central bank is expected to enter a loosening cycle in January amid low growth and falling inflation. Recent activity and inflation data supports our call of a 100-bp easing cycle this year. 

• Fitch placed Chile’s sovereign rating in negative watch due to concerns that weak growth has led to a worsening in fiscal dynamics.

• Uncertainty is set to persist this year as surprise presidential candidate, Alejandro Guillier, consolidates his position at the top of the electoral polls, alongside former President Sebastián Piñera.

Disappointing activity

Non-mining activity continues to weaken, dampening expectations of a recovery. The IMACEC monthly GDP proxy increased 0.8% year over year in November, after a 0.4% contraction in October. The weak reading came in spite of the growth recovery in mining, to 2.2% year over year (from -7.1% previously), while non-mining activity was weighed down by manufacturing.

The fourth quarter is set to be the weakest of the year. Activity in the quarter ending in November expanded by 0.6% (vs. +1.6% in 3Q16) – the lowest rate since October 2009. Mining declined by 2.8% (vs. -0.8% in 3Q16), while non-mining activity posted a modest increase of 0.9% (vs. +1.8% in 3Q16). Activity also contracted at the margin.

After a weak end to 2016, growth is likely to remain subdued going into 2017. The impact of supply-side shocks (reduced fishing output, which has affected manufacturing production, as well as mining disruptions) are expected to ease going forward, butstill-low confidence could cause the low-growth scenario to persist despite the recent increase in copper prices.

Business confidence according to Icare ended 2016 near the historical lows, at 41.5 (50 = neutral), from 42.9 one year ago, while consumer confidence registered an uptick at the end of the year (to 40.1) but completed three years in negative territory.

Unemployment remains low, however the composition of employment growth continues to indicate a less robust labor market. The recent improvement in waged employment was largely related to jobs without contracts, suggesting that companies are employing workers on a temporary – rather than permanent – basis, as the economic outlook is further evaluated.

Alongside low confidence levels and growing uncertainties surrounding the upcoming presidential elections, the latest data puts a downward bias on our 1.5% GDP estimate for 2016 as well as on the 2% recovery expected for this year. Despite the expected pick-up to 2.5% in 2018, the Chilean economy would register a fifth year of below-potential growth.

Inflation on a downward trend

In December, inflation delivered the third downside surprise in the last four months of 2016, as price pressures eased amid weak activity and a stable exchange rate. Tradable goods have led the disinflation in recent months, while inflation of non-tradables has stabilized.

Annual inflation came in at 2.7%, from 2.9% in the previous month and 4.4% in 2015. This is the lowest reading since November 2013. Tradable inflation dipped below the lower end of the target range, at 1.7% (vs. 2.2% previously). Meanwhile, non-tradable inflation remained near the upper limit of the target range, at 4.0% (vs. 3.9% previously). Core inflation (excluding food and energy prices) came in at 2.8% (vs. 3.0% previously) – the lowest reading since March 2014. Service inflation within the core index, which better reflects domestic inflationary pressures, was broadly stable at 4%, in line with non-tradable inflation. Our diffusion index continues to moderate, mainly due to the tradable goods component, but the non-tradable component is also moderating.

We expect inflation to remain within the lower half of the central bank’s 2%-4% target throughout 2017. Inflation would end this year at 2.8% and near the 3% target by yearend 2018.

Ready to cut rates

Although the central bank kept the policy rate at 3.5% in December, one board member voted for a 25-bp rate cut. This is the first split decision since September 2015, when the board held the policy rate at 3.0% before initiating its short tightening cycle the following month. According to the minutes of the meeting, the board believes that additional monetary stimulus is necessary. The latest Central Bank Inflation Report assumes a monetary policy path similar to the one implied by asset prices and surveys at the time that the forecasts were elaborated, which indicate a cycle of only 50 bps.  

We expect the central bank to cut the policy rate to 3.25% in January, with the second rate also in 1Q17. However, given the expectations of weak growth and inflation set to hover around 2% for a significant part of 2017, we anticipate further monetary easing. We see the policy rate ending 2017 at 2.5%, implying a cycle of 100 bps. A partial easing of the monetary stimulus would take place later in 2018 (we see the policy rate ending next year at 3.25%), as activity picks up and inflation gradually returns to the center of the target range.

Following Rodrigo Vergara’s departure, Rosanna Costa was appointed as board member. Ms Costa will be the second woman to serve as board member of the central bank of Chile. Previously, she was head of the Budget Office at the Ministry of Finance during the Piñera administration (2010-2014) and until now was the deputy director of local think tank Libertad y Desarrollo, linked to the political right. Ms Costa will serve the remaining three years of former President Vergara’s appointment, until December 2018.

Strong trade surplus in 2016

The trade balance saw a significant improvement at the end of the year. In 4Q16, exports posted the best performance since the quarter ending in August 2011, expanding by 6.5% from last year after falling 2.1% in 3Q16. According to our seasonally-adjusted series, the trade balance picked up to USD 5.3 billion (annualized) in 4Q16, at the margin, marking an improvement from the USD 3.7 billion recorded in 3Q16, supported by higher copper prices. The full-year trade surplus therefore came in at USD 4.6 billion, above the USD 3.5 billion recorded in 2015. The mining balance (mostly copper exports and oil imports) inched downward relative to 2015, while the non-mining balance deficit narrowed, leading the improvement in the headline figure.

The strong trade figures suggest that the current-account balance deficit for 2016 would come in at 1.7% of GDP, lower than previously anticipated. Soft internal demand growth and the recent recovery in copper prices will help to keep the current account deficit at a moderate level in 2017 (1.8%) and 2018 (1.9%).

The CLP performed well at the end of 2016 (670 CLP/USD), but depreciation is expected ahead. Lower rates in Chile and rate hikes in the U.S. would lead to a weaker CLP/USD by the end of this year (685) and the next (695).

Downgraded fiscal outlook

Fitch Ratings confirmed Chile's Long-Term Foreign and Local Currency Issuer Default Ratings at 'A+' and 'AA-', respectively, but revised the outlook to negative from stable. According to the rating agency, the revision reflects prolonged economic weakness, which has contributed to a relatively rapid deterioration in the sovereign balance sheet. While Chile's sovereign balance sheet continues to be its key strength relative to its peers, it has experienced the fastest erosion of any sovereign in the 'A' category, according to the agency. Fitch projects a general government gross debt of 21.4% of GDP by the end of 2016 – double the level registered in 2011, when Chile was upgraded to 'A+'. Debt could surpass 30% by 2019, still well below the 'A' median of around 50%, but converging with the 'A' median as a share of revenue given the narrower revenue base.

Following the move, Finance Minister Rodrigo Valdés noted that implementing fast fiscal adjustment may have “complex consequences” for the economy. Minister. Valdés added that his main concern is growth and that he believes that the administration’s fiscal strategy of gradual consolidation is appropriate. While the change in outlook was unexpected, we do not anticipate a downgrade by this or any other rating agency (Moody’s: Aa3; SP: AA-) in the short run.

Political outsider makes strides

Alejandro Guillier, an independent left-leaning senator, is leading in a head-to-head contest against ex-president Sebastian Piñera, according to the latest CERC-MORI public opinion survey. The Chilean presidential election will take place in November. The survey has Guillier winning a potential runoff election by 5 points against Piñera. In the first round, the survey showed that Guillier would obtain 19% of the vote, while Piñera would get 23%, not enough to prevent a runoff. Guillier has gained traction as establishment politicians face the backlash of public frustration with corruption scandals and an underwhelming economic performance. There is limited information on Guillier’s views on the economy or a potential government program, and this element of surprise could mean lingering uncertainties going forward (partly reflected in the low business confidence levels). Surveys by other pollsters confirm that the two candidates are consolidating their advantage over the pack. A generalized drop in the number of undecided voters will help reduce the uncertainty going forward.


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.


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