Saturday, June 8, 2019

Chile cuts rate 50 bps in surprise on wider output gap

     Chile's central bank surprised financial markets and investors by cutting its monetary policy rate by 50 basis points to 2.50 percent in response to lower-than-expected growth in the first quarter of this year and a wider-than-expected output gap from the impact of "massive immigration of recent years on trend and potential growth."
     The unanimous rate cut on June 7 by the Central Bank of Chile's (CBC) board surprised many economists because in its previous monetary policy decision from May 9 the central bank did not signal it was considering cutting its rate and CBC is known as transparent and predictable.
      In May CBC began a gradual shift away from its earlier tightening stance by saying it would keep its monetary stimulus in place for an extended time as inflation was sluggish and preliminary data showed first quarter growth was less than expected.
     This shift in May followed rate hikes by a total of 50 basis points in October 2018 and then in January this year when the central bank said it was gradually tightening its policy stance.
     Friday's rate cut reverses these two rate hikes, bringing the rate back to its level from May 2017 to September 2018.
     However, minutes from the board's meeting in May, released on May 27, showed the board had in fact discussed cutting the rate in a preventative and corrective action.
      The board was beginning to realize its monetary policy stance in the past had been less expansive than thought because the output gap was in fact bigger than expected due to positive impact of recent immigration on potential growth.
       Chile took in about 700,000 migrants between 2015 and 2017, many from Venezuela and Haiti. Venezuelans now comprise the largest foreign community in Chile, outnumbering Peruvians who were the largest community only two years ago.
      While some economists had taken note of the board's discussion in May, most thought this meant the central bank would keep its rate on hold for now or maybe cut it later this year after its lowered its growth forecast or the estimate for a neutral interest rate in its June monetary policy report.
      But in its policy statement, the board said the June report, which will be released on Monday, June 10, quantifies the effects of recent immigration on growth, boosting the estimate of potential growth by 25 basis points to 3.25 percent - 4.75 percent for the period 2019 to 2028 and to around 3.4 percent for 2019 to 2021.
      "This, combined with the lower growth of the first quarter, results in a widening of the activity gap," which means the neutral monetary policy rate has been revised down by 25 basis points, partly reflecting the drop in neutral rates around the world.
      The June monetary policy report suggest growth this year will be between 2.75 and 3.50 percent, below the previous forecast of 3.0 to 4.0 percent.
      For 2020 and 2021 growth is forecast between 3.0 and 4.0 percent, reflecting a recovery of growth in the second half of this year and higher potential growth.
      "The board estimates that, in light of the updating of the structural parameters, the economy has not recovered enough to close the activity gap and boost inflation," CBC said, adding"
      "Accordingly, the board has deemed it necessary to recalibrate the monetary impulse," with the new level of its policy rate enough to ensure inflation converges to the target.
      Going forward, CBC said changes to the policy rate will depend on how inflation moves toward its 3.0 percent target, with this depending on the labour market absorbs the inflow of migrants, the level of investment and external developments.
      Chile's gross domestic product slowed to lower-than-expected annual growth of 1.6 percent in the first quarter of this year from 3.6 percent in the fourth quarter of 2018, with the CBC pointing to slower growth of machinery and equipment investment, exports as a consequence of a deterioration in the external markets and a build-up of inventory that failed to reverse as it had expected.
      Headline inflation rose to 2.3 percent in May, but mainly due to higher electricity rates, with core inflation of 1.9 percent and inflation expectations for end-2019 and in 12 months below 3.0 percent.
     CBC's policy decision was released after financial markets closed on Friday, with Chile's peso so far showing little change in response to the rate cut.
      The peso was trading at 692.8 to the U.S. dollar on June 9, steady from levels seen in the second half of last week but up 2.4 percent from last Monday. Compared with the start of 2019, the peso was steady.

     The Central Bank of Chile issued the following statement:

"At its Monetary Policy Meeting, the Board of the Central Bank of Chile decided to reduce the monetary policy interest rate by 50 basis points, to 2.5%. The decision was adopted by the unanimous vote of the Board members.

Regarding the evolution of the external macroeconomic scenario, the main developments of the last month have revolved around the trade conflict, which has permeated other areas of the US-China relationship, plus other US trading partners. Fears that this may lead to a deterioration of the world economy have affected asset valuation, with falls in stock markets and long-term interest rates. Besides, the dollar has appreciated globally and commodity prices have dropped, copper included. In recent days, global financial markets have shown some improvement, hand in hand with signals coming from the central banks of developed countries about their will to boost the monetary impulse. Partial second-quarter inflation and activity data have been below market expectations. It is worth noting the situation of the labor market, manufacturing production and prospects. This coincides with a significant slowdown in global trade, that even posted annual contractions in some months.

With respect to local financial markets, external developments have been transmitted through the exchange rate, stock prices and the fixed-income market. Local risk indicators have also shown some increase, but remain contained. Market prices have factored in a lower MPR. Meanwhile, lending rates have declined recently, and a number of them are at their all-time lows. The publication of first-quarter National Accounts confirmed lower-than-forecast activity growth, because of a poor performance of some more volatile lines related to natural resources, and mining. As for demand, the deceleration of machinery and equipment investment and exports stood out, both falling short of expectations, coinciding with the worsened external scenario during recent quarters and inventory build-up that failed to reverse as expected. Consumption brought no surprises, with a strengthened habitual component. April’s Imacec revealed an improvement of the mining sector and non-mining growth that remained above 2% annually.

Annual CPI inflation —measured using the 2018=100 benchmark base— rose to 2.3% in May (2% in April). As expected, the month’s inflation rate (0.6%) was largely the result of the increase in electricity rates. The CPIEFE stayed near 2% annually. Private inflation expectations available at the time of the Meeting show no big change. For the end of this year and one year ahead they stand somewhat below 3% annually, and remain in the neighborhood two years ahead.

On this occasion, the Board also considered the updating of the structural parameters that are used to evaluate the state of the economy, its outlook, and the calibration of monetary policy, the details of which will be included in the June Monetary Policy Report to be released next Monday at 8:30 hours. Most importantly, this allowed to quantify the effects of the massive immigration of recent years on trend and potential growth. The Board estimates the former in the 3.25% to 3.75% for the period 2019- 2028, and the latter, around 3.4% for 2019-2021. In both cases this means an increase of 25 basis points with respect to earlier estimates. This, combined with the lower growth of the first quarter, results in a widening of the activity gap. Meanwhile, the neutral MPR has been revised downward by 25 basis points, partly reflecting the drop in neutral rates around the world.

Forecasts included in the Report suggest that in 2019 GDP growth will be between 2.75% and 3.5%, and between 3% and 4% in 2020 and 2021, in line with a recovery of growth in the second half of this year and increased potential growth. These projections consider the monetary policy decision of this Meeting.

The Board estimates that, in light of the updating of the structural parameters, the economy has not recovered enough to close the activity gap and boost inflation. Accordingly, the Board has deemed necessary to recalibrate the monetary impulse. The Board estimates that, if the baseline scenario materializes, this change in the MPR will suffice to ensure the convergence of inflation to the target in the policy horizon. Going forward, the onset of the MPR normalization process will depend on inflation clearly advancing to 3%. For this evaluation it will be particularly important the way the labor market will absorb the strong migratory inflow, the response of investment and the external developments. With this, the Board reiterates its will to conduct monetary policy with flexibility, so that projected inflation stands at 3% over the twoyear horizon.

The minutes of this Monetary Policy Meeting will be published at 8:30 hours of Monday 24 June 2019. The next monetary Policy Meeting is scheduled to take place on 17–18 July 2019 and the statement thereof will be released at 18:00 hours this latter day."


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