Shake, Shake, Shake, Señora…
Executive Summary
Natural disasters have fallen upon Chileans in the past month: two consecutive earthquakes and a devastating fire. In spite of the undeniable human drama, the immediate negative economic effects are small, while the reconstruction efforts can become moderately simulative.
But not only is the earth shaking; so is economic activity. In February, the monthly economic activity index (IMACEC) expanded only 2.9% in the 12-months to February (2.8% seasonally adjusted).
After some sign of weakening in January, data from the labor market in February continued to be robust. However, we should expect a further deterioration in the labor market as the deceleration of the economy usually affects this market with a lag.
In the last few months, inflation surprised the markets on the upside while economic activity surprises were on the downside. Some market analysts are talking about stagflation, but there is no evidence of this so far. The rise in inflation numbers is mostly due to very specific price increases, and the bulk comes from non-core prices. Yet the upward trend in inflation is clear.
In its last monetary policy meeting (April 17th) the Central Bank decided to keep its monetary policy interest rate unchanged at 4.0% after two consecutive 25 bps reductions in February and March. In our opinion the decision shows that the Central Bank has a hawkish bias. We believe that it is likely that the Central Bank will keep its policy rate unchanged for a while.
What about the possible inflationary effects of tax reform? If the entire increase in taxes is passed onto final prices, the direct incidence of the proposed changes would be small: a maximum of about 0.2% in 2015 and an additional 0.3% in 2016.
Michelle Bachelet returned to office not only charged with reinvigorating a decades-old coalition, but with implementing a series of reforms aimed at placating an increasingly vocal civil society. Bachelet has transformed the coalition of Socialists and Christian Democrats into a hodgepodge that is both a difficult and unpredictable governing alliance as well as a symbol of what politics will probably look like in the future.
President Bachelet has acted quickly, despite earthquakes and wildfires, to make good on her reform agenda. It is a platform based on three ambitious reforms: taxes, education, and the constitution. With roughly 55% of the seats in both houses of Congress, she can feel fairly confident that many of her proposals will be approved. The question then is at what economic and political cost.
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