Chile Delivers Hawkish Interest Rate Cut That Raises Odds of a Pause to Easing

(Bloomberg) — Chile’s central bank cut its key interest rate by a quarter point for the third meeting and delivered a stern warning on short-term inflation challenges, raising the odds of a coming pause to its easing cycle.

Policymakers led by Rosanna Costa voted unanimously to lower borrowing costs to 5% late Tuesday, as expected by all analysts in a Bloomberg survey except three who forecast no change. Rates have tumbled from 11.25% in mid-2023.

In an accompanying statement, policymakers wrote that the inflation outlook has become more daunting. Chile’s consumer price dynamics have come under pressure from factors including a weaker peso, rising electricity tariffs and higher labor costs that include “significant” wage gains.

“The balance of risks for inflation is biased to the upside in the short term, which highlights the need to be cautious,” policymakers wrote. “The board will gather information with respect to the economy to evaluate the opportunity for further rate cuts in coming quarters.”

Central bankers extended their easing cycle as inflation expectations remain anchored at the 3% target in two years. Domestic activity is facing numerous headwinds — demand from top trading partner China is weakening, while locally unemployment is high and business confidence levels are subdued. Still, global geopolitical and economic volatility is giving reason for caution.

“We interpret the decision as a ‘hawkish cut’ that signals the central bank will take some time to assess if macro conditions allow for additional cuts toward the nominal neutral rate range,” said Andres Perez, chief Latin America economist at Banco Itau. “The easing cycle to pause, for now.”

Board members have estimated the neutral rate — which neither stimulates nor restricts the economy — at between 3.5% and 4.5%. While central bankers signaled in their statement that rates should fall over their policy horizon, they did not reference when borrowing costs will reach the neutral level.

Annual inflation was 4.2% last month, above the central bank’s forecast from September. Consumer prices will remain pressured, most notably due to a new electricity tariff hike scheduled for January as well as a fresh slide in the peso, which has weakened some 11% against the dollar this year.

Given those price drivers, annual inflation is likely to fluctuate around 5% in the first half of next year, policymakers wrote in the statement. Weaker domestic demand will mitigate cost-of-living increases in the medium-term, they wrote.

What Bloomberg Economics Says

“Cautious forward guidance suggests policymakers are poised to hold rates for some time while awaiting evidence that inflationary pressures — from peso depreciation, increasing salaries and higher electricity prices — are transitory. Higher inflation in the first half of next year — as the central bank now projects — and the more cautious outlook suggest they may hold the rate at 5% into the second quarter.”

— Felipe Hernandez, Latin America economist

— Click here for full report

Private consumption was weak in the third quarter while bank credit has been lackluster and job creation has shown “poor performance,” policymakers wrote. Consumer and business expectations are on the pessimistic side, they wrote.

Finance Minister Mario Marcel said this month that gross domestic product will expand 2.4% in 2024, below the government’s most recent forecast of 2.6%. He singled out investment as a top challenge going forward.

Meanwhile, the global outlook has turned more uncertain due to fiscal concerns, possible changes to international trade and the policies that will come once Donald Trump takes office as US president, central bankers wrote. “The financial markets have reacted to this heightened uncertainty with increases in long-term interest rates and a strengthening of the dollar,” they wrote.

“There’s justified caution after the quarter-point rate cut,” Jorge Selaive, chief economist at Scotiabank Chile, wrote on X. “They will probably pause in January and perhaps also in March.”

Chile’s central bank will publish its latest forecasts for economic growth and inflation, as well as the likely path for borrowing costs going forward, in its quarterly monetary policy report Wednesday.

–With assistance from Giovanna Serafim and Rafael Gayol.

(Re-casts story, adds details from central bank statement starting in third paragraph)

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