The March IPoM did not disappoint. After a series of inflation data , significant increases in TPM and major shifts in the external macroeconomic landscape, the Council’s projections were eagerly awaited by the market, which had already been adjusting its expectations for several weeks. We wrote about this last week, when we outlined the most likely strategies the central bank might pursue and our own view on the matter. In all modesty, that is exactly what happened.

However, it all began the day before, at the Monetary Policy Meeting, when the Central Bank raised the TPM by 150 basis points, to 7.00%, in line with our expectations but below market expectations (200 bp). Furthermore, the statement indicated that future rate hikes would be smaller than those in recent quarters, providing relevant insight into what was to come the following day.

In this regard, the IPoM confirmed all of that, with a perspective that could perhaps be interpreted as less inflationary than the market’s and, consequently, that would require fewer monetary policy adjustments. However, compared to the previous scenario, the report projected higher inflation and more TPM hikes—though not as many as the market had been pricing in, which, in our view, had gotten out of hand. Year-over-year inflation exceeding 12% by mid-year, closing at nearly 9% in 2022 and which included key rate hikes of over 10%, seemed excessive to us. Thus, the baseline scenario published by the Central Bank projects inflation that would hover around 10% by mid-year but would slow to 5.6% in December, which would require slight additional adjustments to the TPM, with a peak that could reach 8.5%.

The published macroeconomic outlook still projects high inflation rates for the coming months, especially in the current context of rising food and commodity prices, but with a significant slowdown expected in the second half of the year. Part of this would be due to the sharp economic slowdown the country is expected to experience in the second half of the year, driven by weaker domestic demand, compounded by reduced external momentum. The figures released this morning only served to reinforce this outlook, with February’s Imacec growing by “only” 6.8% compared to the same month last year (expectations were between 8% and 9%), while also showing a sharp contraction from January, with all sectors declining to some extent, including services. Inflation, no longer fueled by the strong demand seen last year, no longer required aggressive monetary policy adjustments.

In any case, we know that the most recent rate hikes have not only been driven by structural factors, but have also sought to realign inflation expectations, which have become unanchored across different time horizons. Qualitative information shared by the Central Bank suggests that at least 50 basis points of the latest increase were driven solely by this factor, which, according to our estimates, could be even higher. This situation could run counter to what was stated in the RPM, since a couple more hikes might not be enough to anchor expectations. However—and this is likely one of the most important points in this report—it was mentioned that the rate cannot be raised indiscriminately until expectations return to desired levels, highlighting that the Central Bank cannot be held hostage by the market and must not overlook the real effects that a highly contractionary interest rate can have on economic activity. That is why the goal is to reach the 3% target within two years, to avoid abrupt adjustments that are undesirable for society, especially in a complex social and public health context such as the current one.

Let's see who was right, but it seems the market has retreated slightly and is now aligning with the Bank’s macroeconomic outlook. The biggest uncertainties likely remain regarding the year-end inflation projection (even we, who are already below the consensus, are still above the IPoM), but there’s still time for that to play out, especially given the external factors influencing it.

Nathan Pincheira | Chief Economist at Fynsa