For about three months, the idea was installed in the market that the Central Bank would begin the normalization cycle of the TPM during this year. There were several arguments, but the main ones had to do with the important economic recovery that we would see in 2021 and some transitory price pressures that might need to be appeased. In any case, the process would be rather conservative, considering the important sources of risk, linked to the evolution of the pandemic, a weak labor market and the constituent process. 

However, since the June 8 meeting (prior to the publication of the June IPoM), there was a feeling that this process would start much earlier. At that time, the change in the bias would only be the prelude to a brutal change in the macro scenario for 2021, with an adjustment of growth expectations by 2 pp (to 8.5% - 9.5%) and of inflation from 3.0% to 4.4% by December. Undoubtedly, such a scenario changed the expected trajectory for monetary policy, which was reflected in a TPM corridor that advanced even the possibility of seeing four 25 bp rate hikes in the remainder of the year, with just four meetings left. The market was surprised because, although there was conviction of an improvement in activity and the possibility of higher prices, the order of magnitude was completely out of consensus.

Given the above, and always mentioning that, for the case of the TPM, our function is not to project what we would do regarding the rate, but to think what is in the Board's head and estimate accordingly, we incorporated two TPM hikes before the end of the year, with the first one starting at the August 30 meeting.

However, we were again surprised. The publication of the minutes of the June meeting caused another shock to agents. Not only had the bias been changed, but it had even been considered, as part of the options, to increase the TPM by 25 bp. In other words, in addition to surprising with the magnitude, it also surprised with how imminent the normalization process was projected to be. What is it that the Board is so concerned about that the rest of the market does not see (or is not able to see)?

 In our view, the concern lies in the inflationary effects of the universal IFE which, as we commented last week, would mean direct transfers to the population of more than US$10.2 billion in three and a half months. But there would not only be demand pressures, but also supply-side pressures, such as inventory problems and the significant increase in maritime freight rates. However, and considering that according to our assessment those effects would be somewhat more moderate and transitory, we believe that some elements that do not represent a risk to consider an imminent increase in the TPM are being left aside. First, inflation expectations are anchored. Historically, de-anchoring and crises have been the only triggers to start processes ahead of schedule and/or to surprise the market. Neither element is present. Secondly, although year-on-year inflation reached 3.6% in May and is projected to exceed 4.0% in the coming months, an important part of it would be transitory and also highly influenced by a low comparison base. To eliminate this effect, we calculate the average inflation of the last 12 months (a la FED), which is at 2.9% and has remained fairly stable in the recent year. A similar result is obtained by looking at the 24-month average. Thirdly, although the economy is projected to close gaps earlier than expected (in fact, this process would already be complete in 2022), heterogeneity between sectors cannot be ruled out, which is particularly relevant when looking at the labor market. Finally, the same Central Bank suggests that the closing of gaps would be transitory, since by 2023 we would see an opening of these gaps again, which explains why the TPM would never be above the neutral TPM throughout the cycle. If an overheating of the economy is not observed today, nor is it projected to occur tomorrow, why hurry?

Therefore, starting to raise the rate from July 14, the date of the next release) seems risky to us. Only one extra CPI and Imacec data will be available with respect to June, which will probably not be enough to determine a bias over the recently published scenario. In the worst case scenario, if indeed prices start to show higher pressures, more significant corrections on the TPM can always be made (e.g. of 50 bp), especially today when the risks of being wrong are very asymmetric.

Nathan Pincheira

Chief Economist of Fynsa