Itaú BBA - Slower Growth Leaves Room for Rate Cuts

Scenario Review - Chile

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Slower Growth Leaves Room for Rate Cuts

Junho 5, 2013

We now expect Chile’s economy to grow by 4.5% this year and by 4.7% in 2014.

Dear clients and friends,

We are proud to present our "Scenario Review - Chile" monthly report. In this series we will discuss the outlook for the main macroeconomic variables of Chile.

We hope you enjoy reading it,

Best Regards,

Ilan Goldfajn

Slower Growth Leaves Room for Rate Cuts

•           Chile’s economy decelerated over the first four months of the year. Although we expect higher growth rates over the next few months, we have revised our growth forecasts downward to 4.5% for this year and 4.7% for 2014

•           As markets price in an earlier reduction of monetary stimulus in the U.S. economy, the Chilean peso weakened rapidly against the dollar. We now see the peso trading at 485 pesos to the dollar by the end of this year and at 475 pesos to the dollar by the end of 2014. 

•           In spite of the weaker exchange rate, we have reduced our inflation forecasts. We now see inflation at 2.2% by the end of this year and at 2.8% by the end of 2014. 

•           Below-trend growth in a very benign inflationary environment will allow for lower interest rates. We expect the reference rate to end this year at 4.25%.

The Economy Weakens

Chile’s economy posted slow growth for the first quarter of the year. GDP increased by 4.1% year over year in 1Q13, following a 5.7% gain in the previous quarter. While calendar effects contributed to the slowdown, seasonally- and calendar-adjusted GDP was also weak, up a modest 2.1% (annualized) compared with 4Q12, which saw a 7.9% gain.

All demand components posted weak growth for 1Q13 after having shown well-above-trend growth in the previous quarter. Private consumption gained 2.9% qoq/saar in 1Q13, compared with a 9.1% gain in 4Q12. Gross fixed investment contracted by 18.8%, after a 26.4% jump in 4Q12. Real exports of goods and services also contracted (by 10.1% qoq/saar), following a 44% increase in 4Q12.

In April, the IMACEC (the monthly proxy for GDP) failed to rebound. The seasonally adjusted index gained a modest 0.2% from March. As a result, activity fell by 2.1% on a quarter-over-quarter and annualized basis. The weak April reading comes in spite of solid growth in retail sales (11.2% year over year in April).

We now expect Chile’s economy to grow by 4.5% this year and by 4.7% in 2014. Both estimates have been revised downward (we were previously expecting a 5.3% increase this year and a 4.8% increase in 2014). In our scenario, therefore, the economy grows at a below-trend rate.

Once Again, a Large Downside Surprise in Inflation

Chile’s inflation figure came in much lower than the market expected in April, at ‑0.5% month over month. The market consensus was expecting a 0.1% deflation. The lower inflation rate was due mostly to lower energy prices (-4.4%), with both electricity (‑9.4%) and gasoline (-3.8%) prices falling sharply from March. Tradable prices fell by 0.9%, but non-tradable inflation was also very low (0% month over month). Inflation excluding food and energy – the core measure closely tracked by the central bank – was negative as well (-0.1%).

As a result, annual inflation fell to 1.0% year over year in April from 1.5% in March. Tradable prices fell by 0.7% from one year before (compared with -0.1% in March), while non-tradable inflation retreated to 3.1% (compared with 3.6% in March). Inflation excluding food and energy fell to 0.8% year over year from 1.1% in March. Thus, Chile’s inflation remains very low, now standing 100 bps below the lower bound of the target range, in spite of a tight labor market. While part of the explanation for the decoupling of the output gap and inflation is the impact of lower commodity inflation and exchange-rate appreciation on tradable prices, non-tradable inflation (which is supposed to be closely related to domestic supply and demand developments) fell back to close to the midpoint of the target range.

We now expect Chile’s inflation to end this year at 2.2% (down from 2.5% in our previous scenario). For 2014, we now see inflation at 2.8%.Our new forecasts take into account the revisions in our GDP growth expectations and the large downside surprise in the April CPI numbers, on the one hand, and a weaker exchange rate, on the other.

Rate Cuts Ahead

Chile’s central bank left the policy rate unchanged in May, but it also introduced an easing bias for the upcoming decisions. According to the minutes of the decision, the board members had also considered cutting the policy rate by 25 bps. The minutes show that the board wants to see more convincing signs that both activity and internal demand are in fact weakening before initiating an easing cycle. That is, the board questioned whether the weakness in 1Q13 was nothing more than data volatility.

We expect the central bank to start an easing cycle in June. We expect 25-bp cuts in each of the next three meetings, so that the policy rate would end both 2013 and 2014 at 4.25%. We note that the last policy decision was made before the downward revision in growth figures for 1Q13 and before the release of the IMACEC for April. In our view, the central bank will read this set of economic indicators as strong evidence that the factors reducing growth in Chile are not just temporary.

The Peso Weakens as U.S. Interest Rates Rise

The current account posted a USD 1.7 billion deficit for 1Q13, taking the four-quarter rolling deficit to USD 11 billion (4% of GDP), up from USD 9.5 billion in 2012. Lower terms of trade coupled with still-solid internal demand continue to widen the current account deficit.

Although net direct investment remains very strong, it is no longer sufficient to fully finance the current account gap. Foreign direct investment amounted to USD 8.8 billion during 1Q13 and USD 34.2 billion over the last four quarters. However, as Chilean direct investment abroad has also been strong, net direct investment came in at USD 9.6 billion over the last four quarters. On the other hand, the portfolio account, which saw a net outflow of USD 3.4 billion in 2012, registered an outflow of just USD 0.1 billion during 1Q13, bringing the portfolio balance over the last four quarters to a USD 0.2 billion surplus.

We forecast current account deficits of 5.0% of GDP this year and 5.3% in 2014. In fact, April’s trade balance numbers show that the 12-month trade surplus continues to narrow, reaching USD 1.2 billion (down from USD 1.5 billion in 1Q13 and USD 3.4 billion in 2012).

As markets price in an earlier reduction of monetary stimulus in the U.S. economy, the Chilean peso, together with most floating-rate currencies, weakened sharply against the dollar. With the fall in copper prices witnessed over the last few months, low global rates were the key factor sustaining the Chilean peso.

We now expect the Chilean peso to end this year at 485 pesos to the dollar and to end 2014 at 475 pesos to the dollar, compared with our previous forecasts of 460 for both years. Lower domestic rates will also contribute to a weaker exchange rate. In our new scenario, the currency will not appreciate enough to trigger an intervention, so we no longer expect the central bank to announce a reserve accumulation program.

João Pedro Bumachar


Forecasts: Chile

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