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ECONOMY | 10-06-2019 14:20

Chile’s Central Bank on its surprise cut: 'You had been warned'

Chile’s Central Bank cut rates last week, seeking to shore up their economies against a worsening US-China trade war.

Chile’s Central Bank may have stunned the market on Friday with a half-point key rate cut, but the June quarterly monetary policy report, known locally as the IPoM, showed the move was in the cards all along.

"As you may recall from our presentation in March, we tied lower inflation to the possibility of bigger slack in capacity due to strong immigration in recent years and lower transfer from exchange rate variations to prices," the Central Bank said in its report published Monday on its website. In March the bank had also warned that parameters like the neutral interest rate, potential GDP, and output gap would be revised in June to reflect weaker-than-expected growth. And last month it also said it had discussed cutting rates, according to the minutes of that meeting.

“The Central Bank had been signalling this since the last IPoM,” said Felipe Hernandez, Latin America economist for Bloomberg Economics, who had forecast a 25 basis point cut. “Potential growth is higher and the neutral rate of monetary policy is lower in a country where inflation is below target.”

Chile’s Central Bank joined countries such as India, New Zealand, Malaysia and Australia, which cut rates last week, seeking to shore up their economies against a worsening US-China trade war. The Federal Reserve has also signaled potential cuts and European Central Bank President Mario Draghi said Thursday policy makers are “determined” to act if needed to support the euro region’s economy.

Local factors

Local factors also explained the move in Chile, as rains affected mining activity in the first months of the year, leading to lower-than-expected 1.6 percent growth in the first quarter. A key motive for the central bank was inflation of non-tradable goods, which had been above three percent for a long time and is now below that level, according to Sebastian Cerda, head of research at Econsult.

"It’s a virtue when a central bank is predictable, but when it sees a change in its scenario, it’s important that it informs this rapidly," Cerda said in an interview at Pauta Bloomberg. The central bank "is seeing an inflation that is showing signs of permanently remaining below its target."

Consumer prices rose 2.3 percent in the 12 months to May, and has been below its three percent target since October. Last week’s rate cut is enough for inflation to converge to target, central bank President Mario Marcel said Monday, adding that the base scenario is for borrowing costs to remain stable.

"It’s certain that our decision surprised the market," he said. "It was a quicker reaction than in other moments because at other times things changed more gradually."

2019 estimates

In the report published Monday, the Central Bank also cut growth, investment, and domestic demand forecasts for this year. Growth in 2019 will be between 2.75 percent and 3.5 percent, down from a range between three and four percent from the March report.

Its forecast for domestic demand was also slashed to 2.9 percent from 3.7 percent while its investment forecast was cut to 4.5 percent from 6.2 percent. The Central Bank also increased estimates for growth in 2021, and domestic demand and investment in 2020 and 2021.

“This is all a part of the global context where rates are getting lower and risks of a trade war remain – what surprised us was the moment in which the central bank, which usually takes time to prepare the market, cut the rate,” said Sebastián Díaz, economist at Pacifico Research.

by Daniela Guzman, Bloomberg

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