A Hole in the Pocket

CHILE - Report 23 Jun 2014 by Igal Magendzo, Robert Funk and Alberto Etchegaray

Executive Summary

It continues to be chilly in Chile. Growth is increasingly meager and there are no signs of a prompt recovery. To the fall in investment we now can add a deceleration of consumption. Apparently investment has hit bottom, but there are clear signs that consumption is still decelerating. Adverse external conditions can explain part but not all of the deceleration. Uncertainty surrounding the reforms, especially tax reform, has deteriorated confidence in the economy.

Even though wages continue to expand at relatively high rates, unemployment remains low and jobs continue to grow at healthy rates. The composition of job creation between "self-employed" and "payroll" categories is changing dramatically in favor of the first. This in itself can be detrimental for consumption.

The CPI accumulated a 12-month variation of 4.7% in May 2014, up from 4.3% in the previous month. Measures of core inflation increased between April and May. The Central Bank insists that this is a rather transitory phenomenon, driven by the sharp depreciation of the peso during the last year. But diffusion indices show that the increase in monthly inflation in the last few months have been broad based. Furthermore, not only products that are affected by the exchange rate have risen in price.

In the June Monetary Policy Meeting, and for a second month in a row, the Central Bank kept the monetary policy interest rate unchanged at 4%. Just like the last time, the tone of the communique was very dovish. But the Central Bank does not feel comfortable with cutting rates when inflation is so high. This was widely expected, so no surprise this time​

Since February the exchange rate has fluctuated between 545 and 573 pesos per US dollar. These levels were not seen since the sharp devaluation that followed the fall of Lehmann in the end of 2008. The devaluation is evidence that the floating rate regime in Chile, were the exchange rate helps to absorb foreign shocks, is working.

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