For approximately three months, the market has been convinced that the Central Bank would begin the cycle of normalizing the MPR this year. There were several arguments for this, but the main ones had to do with the significant economic recovery we would see in 2021 and some temporary price pressures that might need to be eased. In any case, the process would be rather conservative, considering the significant sources of risk linked to the evolution of the pandemic, a weak labor market, and the constitutional process. 

However, since the meeting on June 8 (prior to the publication of the June IPoM), there has been a sense that this process would begin much earlier. At that time, the change in bias would only be the prelude to a brutal macroeconomic scenario change for 2021, with an adjustment of growth expectations of 2 pp (to 8.5%–9.5%) and inflation from 3.0% to 4.4% in December. Undoubtedly, such a scenario changed the expected trajectory for monetary policy, which was reflected in a MPR corridor that even anticipated the possibility of four 25 bp rate increases in the remainder of the year, with only four meetings left. The market was surprised because, although there was conviction that activity would improve and prices would rise, the order of magnitude was completely outside the consensus.

Given the above, and always bearing in mind that, in the case of the MPR, our role is not to project what we would do with regard to the rate, but rather to consider what is on the Council's mind and make an estimate accordingly, we have incorporated two MPR increases before the end of the year, with the first beginning at the August 30 meeting.

However, we were surprised once again. The publication of the minutes of the June meeting caused another stir among market participants. Not only had the bias changed, but raising the MPR by 25 bp had even been considered as one of the options. In other words, in addition to surprising with the magnitude, it also surprised with how imminent the normalization process was projected to be. Why is this? What is it that worries the Council so much that the rest of the market does not see (or is unable to see)?

 In our view, the concern lies in the inflationary effects that universal IFE would cause, which, as we discussed 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, as there would also be supply pressures, such as inventory problems and the significant increase in maritime freight rates. However, considering that, according to our assessment, these effects would be somewhat more moderate and temporary, we believe that some elements are being overlooked that do not pose a risk sufficient to consider an imminent increase in the MPR. First, inflation expectations are anchored. Historically, unanchoring and crises have been the only triggers for initiating processes earlier than expected and/or surprising the market. Neither of these elements is present. Second, although year-on-year inflation reached 3.6% in May and is projected to exceed 4.0% in the coming months, a significant part of it would be temporary and also heavily influenced by a low base of comparison. To eliminate this effect, we calculated the average inflation rate for the last 12 months (as per the Fed), which stands at 2.9% and has remained fairly stable over the past year. A similar result is obtained when looking at the 24-month average. Third, 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 Central Bank itself suggests that the closing of gaps would be temporary, as we would see them reopen by 2023, which explains why the MPR would never be above the neutral MPR throughout the cycle. If the economy is not overheating today, nor is it projected to do so tomorrow, why rush?

Therefore, we believe that beginning to raise rates on July 14, the date of the next announcement, would be risky. Only CPI and Imacec data for June will be available, which is probably not enough to determine a bias on the recently published scenario. In the worst-case scenario, if prices do indeed begin to show greater pressure, more significant corrections can always be made to the MPR (for example, 50 bp), especially today when the risks of making a mistake are highly asymmetrical.

Nathan Pincheira

Chief Economist at Fynsa