Chile’s economy is recovering more quickly than we had previously expected and, as a result, we are revising up our 2020 GDP growth forecast to -5.5% (previously -7.0%). The stronger rebound has eased pressure on the central bank to loosen monetary policy further – we now expect policy settings to remain unchanged into 2022. This view is still more dovish than the path discounted in financial markets.
- Chile’s economy is recovering more quickly than we had previously expected and, as a result, we are revising up our 2020 GDP growth forecast to -5.5% (previously -7.0%). The stronger rebound has eased pressure on the central bank to loosen monetary policy further – we now expect policy settings to remain unchanged into 2022. This view is still more dovish than the path discounted in financial markets.
- Chile’s recovery got off to a sluggish start. After collapsing in May, the monthly economic activity index (which has a strong relationship with the quarterly GDP data) shows that output expanded by just 0.8% m/m in June and 1.7% m/m in July, leaving output 14.1% below its pre-virus February level. (See Chart 1.)
- But the initial weakness of the rebound was due mainly to the decision by Chile’s government to double down on lockdown measures to try to stamp out the virus, which has had some success. And growth in the second half of the year is shaping up to be stronger than we had expected. The fall in virus cases since June (see Chart 2) has allowed policymakers to begin lifting restrictions. And it also appears to be reducing consumers’ precautionary behaviour. Indeed, our Mobility Tracker suggests that this coincided with a marked improvement in activity last month. (See Chart 3.)
- Moreover, a recent reform to allow households to withdraw some pension savings is likely to boost consumption. We flagged this as an upside risk to our forecast previously. (See here). At least some of the estimated 6% of GDP worth of withdrawn funds is likely to be spent in Q3 and Q4. All told, we are revising up our 2020 GDP growth forecast to -5.5% (previously -7.0%). And the bigger picture is that we continue to expect Chile to perform better than most countries in the region over the coming years.
- One consequence of a stronger recovery in the coming months is that further monetary policy easing now looks unlikely. In the context of activity picking up, the central bank will be less pressed to expand its already significant stimulus measures.
- This helps to explain why policymakers have become less dovish in their latest statements. In its earlier June Monetary Policy Report, the central bank noted that “the board especially appreciates congressional support for legal reform that would expand the Bank’s powers to act”. This was referring to a bill that would allow the central bank to purchase sovereign debt.
- But while this bill has now been passed, policymakers opted not to take advantage of their newly acquired powers at the September meeting. What’s more, there was no mention of sovereign bond purchases in the September policy statement or the quarterly Monetary Policy Report. The September statement also noted that the board will “maintain the unconventional measures now in place”, rather than “assess other options to intensify the monetary impulse using unconventional methods” (as in the June statement).
- Another reason why further monetary easing looks unlikely is diminished concerns over the consequences of the pension withdrawal bill. While the bill initially appeared to increase Chile’s 10-year local currency bond yield, the impact has now unwound. (See Chart 4.) As a result, the central bank should feel less pressure to intervene to bring down long-term yields.
- Accordingly, the central bank now looks unlikely to expand the size or scope of its special asset purchase programme. And we no longer expect another 25bp cut in the policy rate this year. We instead think the central bank will maintain the policy rate at 0.50% over the next two years.
- Of course, the key risk to our view is a renewed surge in daily virus cases and/or a fresh lockdown, which would bring further monetary easing back onto the agenda. Either way though, the view discounted in financial markets – for 50bp of hikes over the next two years – looks too hawkish.
Chart 1: Imacec Econ. Act. Index (SA, Feb. 2020 = 100)
Chart 2: Chile New Daily Coronavirus Cases (7d Avg.)
Chart 3: Chile Mobility Tracker (% Difference from Jan. 6-Feb., 7d Avg.)
Chart 4: Chile 10Y Local Curr. Sov. Bond Yield (%)
Sources: Refinitiv, Google, Capital Economics
Quinn Markwith, Latin America Economist, firstname.lastname@example.org