Home Brokerage Can Rate Cuts Support Stronger Economic Growth for Chile in 2024?

Can Rate Cuts Support Stronger Economic Growth for Chile in 2024?

by internationalbanker

By Valerie Hernandez, International Banker

 

In March, Chile’s annual inflation rate slowed to 3.7 percent, its lowest level since May 2021, before ticking back up to 4.0 percent in April. Nonetheless, the broader long-term trend of slowing price rises since August 2022, when inflation peaked at 14.1 percent, has been encouraging news for the central bank (Banco Central de Chile), which has been sharply cutting interest rates since late July 2023 to turbocharge Chile’s growth prospects. Indeed, with Chile recording a meagre 0.2-percent growth in its gross domestic product (GDP) in 2023, more rate cuts this year should see stronger performance from the South American economy in 2024 and beyond.

Chile commonly uses its own Monthly Economic Activity Index (Imacec) as a proxy for GDP—a measure that “summarises the activity of the different branches of the domestic economy in a given month”, according to Banco Central de Chile (BCC). Recent data shows that the Imacec index rose month-on-month in January and February by 2.5 percent and 4.5 percent, respectively, to mark a welcome turnaround from the previous run of four consecutive monthly declines at the end of 2023, suggesting a more buoyant 2024 was on the horizon. However, the Imacec fell by 0.7 percent month-on-month in March, slightly more than the minus-0.6-percent median estimate delivered in a Bloomberg survey, but still gained 0.8 percent on an annual basis.

So, why the decline in March? According to BCC, growth in mining and other goods was offset by drops in trade and manufacturing. “Goods production rose 3.7 percent annually, mainly due to the 8.2 percent increase in mining, followed by the 2.7 percent increase in other goods driven by power generation. Meanwhile, manufacturing dropped 2.3 percent,” the central bank noted. “Trade activity posted a decrease of 5.3 percent in annual terms, explained by automotive and wholesale trade. Worth noting were the lower sales of vehicles in the former and lower sales of foodstuffs in the latter. By contrast, retail sales increased.” Unemployment also ticked up in March to 8.7 percent from 8.5 percent in February.

Nonetheless, expectations remain for Chile to register solid growth this year, suggesting that the March Imacec reading was more of a blip than a long-term trend of monthly contractions. “The economy should continue with a gradual recovery in the face of the greater external impulse due to the improvement in the terms of trade and local financial conditions,” César Guzmán, macroeconomics manager at Inversiones Security, wrote in a report in early May.

This assessment reaffirms what most analysts have been predicting this year, moreover. “We expect the economic activity to return to trend GDP growth rates in 2024 on the back of more favourable interest rates, lower inflation and a more stable political outlook. These factors will boost private consumption, and investment will also recover slowly,” Banco Santander Chile’s economists noted in February. “A general relaxation of monetary policy expected from Chile’s central bank and counterparts around the world will have a positive impact. We estimate GDP to grow by more than 1 percent in the first half of 2024, hitting 2 percent by year-end.”

Goldman Sachs, meanwhile, has pointed to a strong expected recovery in demand from China this year as being particularly supportive of growth in Chile. “High inflation, a very restrictive monetary stance, tighter global financial conditions and policy uncertainty continue to be headwinds for activity,” Sergio Armella, an economist at Goldman Sachs, stated in a recent note. “Still, we remain more constructive on growth than the central bank…and see potential upside from the impact China’s reopening could have on Chile via a positive terms-of-trade shock.”

According to BMI Research, a Fitch Solutions company based in the United Kingdom, Chile’s GDP growth will rebound to 1.8 percent in 2024 on the back of stronger private consumption and a recovery in the mining industry. “Our expectations of a very strong rebound in private consumption are based on the recovering labour market and fairly moderate inflation,” BMI noted in March.

“Although we saw an uptick in headline inflation in February 2024, inflation has come down dramatically since its peak of 13.3 percent year-on-year in November 2022. The Banco Central de Chile (BCC) has engaged in a fairly aggressive cutting cycle as growth remained lacklustre through 2023, thereby improving conditions for business and consumer borrowers,” BMI added. “We have already seen a notable increase in the number of loans taken out in the last few months. With the bank expected to cut further this year to 5.00 percent by end-2024, from 7.25 percent currently, we will see reduction[s] in borrowing costs translate into accelerated credit growth for consumers and businesses in the months ahead.”

Indeed, the crucial monetary easing expected over the coming months should prove to be the decisive factor in boosting Chile’s GDP growth this year. Most recently, BCC lowered its benchmark monetary policy interest rate (MPR) by 75 basis points (bps) on April 2 to 6.5 percent. “Inflation in January and February exceeded expectations, which increased the annual variation of the CPI—spliced reference series—to 3.6 percent (3.2 percent in January),” the central bank explained in a statement regarding its early-April monetary-policy meeting. “Among other factors, this evolution responded to the depreciation of the exchange rate, external price hikes and the adjustment of some local prices. Regarding two-year inflation expectations, both the Economic Expectations Survey (EEE) and the Financial Traders Survey (EOF) are at 3 percent.”

That said, April’s rate cut was 25 basis points less than the 100-basis-point cut that BCC approved in its previous meeting in late January, with board members noting that although domestic demand remained weak, this smaller drop provided more leeway should their economic projections fail to materialise. “Although the peso depreciation and global cost shocks pointed to greater pressure on prices, both factors would tend to dissipate within the monetary policy horizon,” they explained in the meeting minutes published on April 17. “Moreover, given the slack in sectors linked to goods consumption, the pass-through of their effects on inflation would be moderate.”

While further rate cuts are expected before year-end, some economists forecast BCC to slow its pace of monetary easing over the coming months, with a half-point rate cut increasingly expected to be administered at its May 23 monetary policy meeting. “The slightly larger-than-expected rise in Chile’s inflation in April supports our view that the central bank will once again slow the pace of easing with a 50bp cut (to 6.00 percent) at its meeting later this month,” Kimberley Sperrfechter, emerging markets economist at Capital Economics, wrote in a note.

BCC has also acknowledged that while the Chilean economy was broadly recovering, certain sectors were underperforming. Specifically, the country’s commercial, construction and real-estate sectors continued to lag, which could prove damaging to the economy should the incidence of defaults rise. “The external scenario continues to be the main source of risks for local financial stability,” the central bank noted in its half-year financial stability report, which also confirmed that the finances of local companies and individuals had largely improved.

At the consumer level, the central bank observed that more Chileans were failing to meet mortgage payments, although the total number of such individuals remained low in absolute terms. The report also stated that rising incomes and lower financial burdens were stabilising household finances this year. And with external macroeconomic risks heightened, the document recommended strengthening the domestic financial market to restore its depth to pre-pandemic levels.

With planned rate cuts in the United States delayed this year as inflation persists above the Federal Reserve’s (the Fed’s) formal target, moreover, the widening differential with BCC’s monetary policy may also pose a distinct risk to Chile’s economic outlook. With US rates being held firm at 5.25-5.50 percent since July 2023 and Chile’s benchmark rate being cut from 11.25 percent to 6.5 percent over the same period, the impact on the peso, in particular, has been dramatic, with Chile’s currency weakening to near-record lows in late February.

“A weighted average of key interest spreads moves to below the historical average on the next cut from Banco de Chile. We enter the ‘dodgy zone’. For this to be a sustainable outcome, the Federal Reserve needs to start cutting rates,” ING reported on March 20, prior to BCC’s early-April rate cut. “The problem is the likelihood for a Fed cut has slipped into mid-summer, and realistically to July (on the market discount). That’s quite a waiting game, one that means exposure to vulnerability.”

 

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