Itaú BBA - No further rate cuts

Scenario Review - Chile

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No further rate cuts

Outubro 5, 2017

Recovery gains traction

Please see the attached file for all graphs.

• Activity is showing signs of firming in 3Q17, in line with the expectation of a recovery in the latter part of the year. We now expect growth of 1.7% this year (1.3% previously; 1.6% in 2016), with a pick-up to 2.7% next year (2.5% previously) aided by higher copper prices, the lagged effects of expansionary monetary policy and low inflation.

• As copper prices have remained elevated, we now see the Chilean peso ending the year at a stronger level than in our previous scenario. We expect the exchange rate to end the year at 665 pesos per dollar (versus our previous estimate of 675) and to reach 675 pesos per dollar by the close of 2018 (685 previously). Our expectation of a weakening from current levels of roughly 632 per dollar is based on the likelihood of continued monetary-policy normalization in the United States.

• The central bank’s 3Q17 inflation report indicates that the central bank‘s base case is for rates stability. The lack of conviction from the board on the need to deliver more stimulus has led us to shift from expecting further rate cuts to a call that the policy rate will remain unchanged for the time being (yearend rate at 2.5% versus 2.0% previously).

Signs of recovery

Industrial production indicators support the view that activity is recovering. Once again, mining output led industrial activity in August – reaching its highest level since June 2015 on a seasonally adjusted basis – but the improvement in activity was widespread. Meanwhile, private consumption activity continues to be driven by the durable component. As a result, the GDP proxy increased by 2.4% in August (2.8% in July) and by 2.2% in the quarter ending in August (0.9% in 2Q17). 

In the quarter ending in August, industrial production growth accelerated to 2.2% (-1.7% in 2Q17 and -5.9% in 1Q17). Manufacturing remained dynamic, growing by 1.9% in the quarter (-0.9% in 2Q17 and -0.4% in 1Q17), while mining production resumed growth (+2.5%) for the first time since November 2015 (-3.4% in 2Q17 and -13.4% in 1Q17). We reiterate our view that the recent boost in mining activity is likely to be temporary; activity in the sector will probably moderate in the coming months because ore grades remain low and investment in the sector has been weak for several years. The improved industrial production is in line with the recent trend in business confidence, which has stayed above its corresponding 2016 levels for the last seventh months and is moving towards neutral (it hit 48.3 points in September, nearly 5 pp above its level of one year prior; 50 = neutral).

Private consumption grew by 3.8% in the quarter ending in August (2.8% in 2Q17), although the labor market data remains fragile, casting doubt on the continuity of the recovery in consumption. A significant portion of the job gains have been in the public sector. As fiscal consolidation unfolds, the support for the labor market from the public sector is unlikely to persist. Meanwhile, the formal private sector remains weak, having shed jobs recently.

All in all, the recent data is consistent with a recovery of the economy. Higher global growth is boosting copper prices, while monetary policy remains expansionary. We now forecast growth of 1.7% this year (1.3% previously). For 2018, we expect 2.7% growth (2.5% previously). The outcome of the presidential election and the debate over the reform agenda next year will have a significant influence on confidence and investment, and consequently on growth. 

Mining exports boost trade

In the month of August, the trade balance surprised market analysts to the upside, boosted by mining exports. The USD 597 million trade surplus was above the market consensus estimate of USD 125 million, resulting in a comfortable rolling 12-month surplus of USD 5.1 billion (USD 5.3 billion in 2016). Our seasonally adjusted series shows that, at the margin, the trade balance surplus climbed to USD 8.2 billion (annualized) in the quarter ending in August, largely due to a rebound in mining (which is recovering after the end of a strike at a key mining site, also benefiting from higher copper prices), from the USD 2.6 billion annualized surplus recorded in 2Q17 (USD 1.0 billion in 1Q17). 

We expect the current-account deficit to remain low this year as internal demand stays weak, the effects of the mining strike continue to fade and copper prices remain high. We see a current account deficit of 1.4% of GDP, in line with the deficit recorded in 2016. A stable deficit as a percentage of GDP is expected for next year.

As copper prices have remained elevated, we now see the Chilean peso ending the year at a stronger level than in our previous scenario. We now see the exchange rate ending the year at 665 pesos per dollar (675 previously) and ending 2018 at 675 pesos per dollar (685 previously). Our expectation of a weakening from current levels is based on the likelihood of continued monetary policy normalization in the United States.

Limited inflationary pressures

August consumer prices were in line with market consensus forecasts, with inflation remaining low. Overall inflation inched up to 1.9% year over year (from 1.7% in July), nearing the lower bound of the central bank’s 2%-4% target range. The pickup was due to tradable inflation becoming less of a drag for the first time since March, aided by a low comparison base. Meanwhile, non-tradable inflation was broadly stable, just above the 3% target and in line with the year-to-date average. 

A rally in global oil prices prevented tradable inflation from declining further. Nevertheless, tradable items remained the main drag on inflation, at 0.7% year over year (0.3% in July), supported by the strengthening of the currency. Meanwhile, August non-tradable inflation was 3.3% (3.4% in July). Excluding food and energy prices, inflation dropped to 1.8% (from 2.0% in July), while other core inflation measures dipped by 0.1 pp, to 1.9%. Excluding food and energy, service inflation was stable at a comfortable 3.3%.

Our diffusion index remained at low levels and is now broadly unchanged since June, showing that price pressures are limited. This view is reinforced by the dynamics at the margin, with last-three-month cumulative inflation staying broadly stable from the end of 2Q17 through August – both the headline figure (0.1%, seasonally adjusted and annualized) and the non-tradable component (2.6%). Excluding food and energy prices, meanwhile, accumulated inflation in the past three months fell to 0.5% in August from 1.4% in 2Q17, with goods inflation going down to -1.9% (from -0.2%).

We expect inflation to remain low for the remainder of the year (2.4% at year-end) and to remain below the target in 2018 (2.8% year-end). 

Unwilling to deliver more stimulus

The central bank’s 3Q17 inflation report (IPoM) differed little from the previous edition: the board sees no need for further easing in the baseline scenario, and a normalization (hiking) process is not on the near-term horizon. The central bank implemented a 100-bp easing cycle (to 2.5%) in the first five months of the year as the economy weakened, while inflation remained under control. Since the previous edition of the IPoM, inflation for this year has run below the central bank’s expectations; meanwhile, activity did not deteriorate further. The baseline trajectory for the policy rate considered by the central bank diverged from various surveys released in the lead-up to the publication of the report that included one additional 25-bp rate cut before year-end.

Following the publication of the IPoM, a united board of the Chilean central bank voted to hold the policy rate at 2.5% in September. The decision was expected, but the unanimity differed from the previous two meetings at which Pablo Garcia opted for a 25-bp cut. In line with the IPoM, the central bank has not closed the door entirely to more easing if downside risks to inflation materialize and affect the target convergence trajectory. Nevertheless, the decision by Mr. Garcia to abandon his call for a cut, the little conviction shown by other members of the board for the need to ease further and recent activity recovery lead us to believe that the likelihood of more easing has significantly diminished. 

In this context, we no longer expect the board to lower the policy rate from the current 2.5% (previously our yearend call was 2.0%). Regardless of our new expectation for monetary policy, there remains a possibility that inflation disappoints and the trajectory of inflation to the 3% target is altered, reopening the discussion for additional stimulus.

Public expenditure to be a 2018 growth driver

The government withdrew its urgency motion calling for Congress to debate a bill that would create a state-appointed “collective savings council” to manage the new pension savings. The authorities justified their move by indicating that the September holiday schedule could lead to high absenteeism among lawmakers, negatively affecting the discussion of the bill. The initiative is part of a broader reform which will require employers to contribute up to 5% of employees’ gross salaries to pensions on top of the current 10% contribution to individual accounts. The urgency motion that accompanied the bill’s submission (August 10) was aimed at having Congress approve the bill before presidential and congressional elections in November. However, with a contentious debate ahead and a busy congressional agenda, the government seems to have opted to give priority to other initiatives (such as the 2018 budget).

The administration presented its 2018 budget plan to Congress. Under the plan, public expenditure would see a real growth rate of 3.9% next year (4.6% estimated for 2017), meaning it continues to be a growth driver given our 2.7% growth forecast (3% according to the government). 

In nominal terms, the budget would come to approximately USD 70 billion (24% of GDP), with a deficit that the government sees close to 1.9% of GDP (2.7% expected for this year). The budget goes in line with the administration’s commitment to decreasing the structural-balance deficit by 0.25% from this year (to 1.5% of GDP), with the cyclical component explained by the growth cycle (rather than copper prices). Health and education receive the bulk of the budget and will see expenditure growth of 6.9% and 5.9%, respectively, from this year. The budget assumptions include a growth recovery to 3.0% (from 1.5% this year) as the average copper price rises to USD 2.88/lb, from USD 2.71/lb expected for this year. Yearend inflation will pick up to 2.8% next year from 2.4% this year. Versus the expected income for this year, the budget envisions revenue growth of 7.4% (5.0% this year) boosted by private mining contributions. Given our lower GDP growth forecast for 2018 and lower average copper prices, we forecast a less optimistic fiscal deficit narrowing to 2.5% of GDP for next year.

Following the recent credit rating downgrades by two of the three main agencies, the 2018 budget proposal signals Chile’s commitment to fiscal responsibility but questions remain as to whether the proposal is austere enough to address the rising debt levels and prevent further rating action.

Leading up to the November 19 presidential election, public opinion surveys are starting to show Alejandro Guillier (whose candidacy is supported by the majority of the parties in the ruling coalition) consolidating a second-place position behind former president Sebastian Piñera. With neither candidate expected to win a simple majority on the first attempt, a second-round vote in December is likely. The Cadem survey (weekly average for September 6-29) indicates that support for Piñera was broadly unchanged from the previous month, at 43%, after being adjusted for likely participation. Alejandro Guillier’s support was at 21% (up 1 pp), while support for Beatriz Sanchez from Frente Amplio dipped by 2 pp, to 15%. Cadem’s simulations for a runoff vote show Piñera with a 12 p.p. lead over Guillier (in line with the August results). Versus Sanchez, Piñera extended his advantage to 14 pp from 11 pp one month ago. Clarity on the political agenda after the presidential election will be key for a meaningful and sustained rebound of confidence and investment in Chile.


João Pedro Bumachar
Vittorio Peretti
Miguel Ricaurte


Please see the attached file for all graphs.

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