Next week—specifically on Wednesday—the Central Bank will release its March Monetary Policy Report, likely one of the most eagerly awaited reports in recent memory. The economic landscape has changed significantly over the past three months, not only because of the data we’ve seen on the domestic economy (primarily inflation) but also due to external developments, particularly Russia’s invasion of Ukraine.

In this regard, monetary policy has had to be adjusted along the way, with significant increases in the TPM and a message pointing to further hikes in the near term. While this is nothing new in terms of direction, it has been new in terms of the magnitude of each of these adjustments and the “terminal” level of the rate. To put this into perspective, a few months ago, the market expected the TPM to reach 6%, whereas today it projects that it will exceed 10%, which would lead to a monetary policy even more contractionary than the one in place during the Asian crisis (the rate peaked higher then, but in comparable terms, it was less contractionary). This is in response to the high inflation currently affecting our economy, which is climbing to nearly 8% but is likely to exceed 9% (both year-over-year) by mid-year.

However, we must be careful about demanding that the Central Bank do something that may be beyond its control. The higher inflation rate observed in 2021 was driven by domestic factors, which, in turn, exacerbated external factors. Controlling this through the TPM is standard practice. But for some time now, we have begun to see a shift from domestic sources to external ones, which—though still in their early stages—shed some light on the true limits of monetary policy in controlling current inflation. If, at some point, price fluctuations are driven by food, fuel, and other volatile items, the Central Bank’s scope for intervention becomes limited. This is when effective communication will be vital, so that the public understands that this additional inflation is transitory—not necessarily within the Central Bank’s control—but that, once the shock has subsided, prices will return to their usual year-over-year increase of 3%.

That’s why the report is so eagerly awaited. Because if our assessment is correct, the market will have to revise its projections for the TPM downward, and this would inevitably trigger a drop in short-term rates. If, on the other hand, the Central Bank sends a message along the lines of “raise rates until it hurts,” yield curves could flatten even further—and we can’t rule out a complete inversion of the curve and all that that implies for expectations. We’ll see what this new Monetary Policy Committee has in store for us, with the first IPoM meeting chaired by Rosanna Costa.  

Nathan Pincheira 

Chief Economist at Fynsa