Few Sweet Words

CHILE - Report 25 Jun 2014 by Igal Magendzo, Robert Funk and Alberto Etchegaray

​Executive Summary

It’s still chilly in Chile. Growth is ever more meager, with no sign of a quick recovery. To the fall in investment we now can add a slowdown in consumption. Though investment has apparently hit bottom, there are clear signs that consumption is still falling. Adverse external conditions can explain part, but not all, of the slowdown. Uncertainty surrounding the reforms, especially tax reform, has damaged confidence in the economy.

Even though wages continue to expand relatively rapidly, unemployment has remained low, and jobs continue to expand at a healthy clip. The composition of job creation between the "self-employed" and "payroll" categories is also changing dramatically, in favor of the former. This in itself can be detrimental to consumption.

Twelve-month CPI rose 4.7% in May, up from 4.3% in April. Measures of core inflation also increased between April and May. The Central Bank insists that this is a transitory phenomenon, driven by the sharp depreciation of the peso over the past year. But diffusion indices show that the increase in monthly inflation over the last few months have been broad-based. Furthermore, other products not affected by the exchange rate have risen in price.

In its June Monetary Policy Meeting, and for a second month in a row, the Central Bank kept its 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 cutting rates when inflation is so high. Its action was widely expected, and so was no surprise this time.
Since February, the exchange rate has fluctuated between 545 and 573 pesos per dollar. Such levels have not been seen since the currency plunge that followed the collapse of Lehmann Brothers, at the end of 2008. This amounts to 16% devaluation in six months, or 12.7% in real terms in the 12 months to April 2014. Such devaluation is evidence that the floating rate regime in Chile, where the exchange rate helps to absorb foreign shocks, is working.

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