The big debate these days revolves around local inflation. Who would have thought it, after so many years when this wasn’t even an issue? In fact, not long ago, people were expecting inflation to hit—whether due to exchange rate issues, the closing of economic gaps, rising oil prices, etc.—but it never materialized. If you don’t believe me, check the reports from local (and even foreign) research departments from the years leading up to the pandemic, and you’ll see that this was indeed the case. It wasn’t just in Chile: around the world, it was a mystery why—with growing economies, high employment, and rising wages—prices remained stable.

“We’re not in Kansas anymore,” and today, for various reasons, inflation is THE issue. Locally, almost everything is contributing to this: a strong local recovery in several sectors (though not all), currency depreciation, rising oil prices, the possibility of increases in other energy prices, shortages of various goods due to disruptions in international supply chains, significant increases in ocean freight rates, withdrawals from pension funds, government transfers, and so on. In July, the Central Bank raised its year-end forecast to 4.4%, and everyone (myself included) thought it was an exaggeration. Today, that figure seems like a conservative estimate, especially since so much—perhaps too much—has changed in the macroeconomic landscape since then.

The year-over-year price change reached 4.5% in July, following a surprising 0.8% month-over-month increase that month, which set off numerous alarms. I agree that not all inflation stems from demand—which makes a big difference when discussing the issue at hand—but a significant portion of it does. And if we combine that excess demand with the shortage of supply, it’s like combining hunger with the desire to eat.

In this context, the Central Bank has already begun a process of monetary normalization, which started at the last meeting with a 25-basis-point hike, bringing the TPM to 0.75%. The message conveyed in that statement and in the minutes was received by the market as “less hawkish” than previous signals, leading some to project that there would not be a string of rate hikes and that the entire process would be handled with caution. Developments since then—the extension of the IFE, the possibility of a fourth withdrawal, the currency depreciation, etc.—have shifted market sentiment and, I have no doubt, that of the Council as well. Thus, the mood has shifted from caution to urgency, with some arguing that the Central Bank might even surprise the market at its August meeting with a 50-basis-point increase, and it cannot be ruled out that such hikes could be repeated in October and December.

Now, don’t get me wrong. I think that scenario is entirely possible. However, I don’t think they’ll go through with it—at least not yet. The Monetary Policy Meeting will be held on August 31, prior to the release of the IPoM on September 1. Obviously, that meeting will take into account the scenario outlined in that IPoM, not the “current” one for July. Therefore, at that time, we won’t have additional inflation figures—perhaps some preliminary growth data for July—but, more importantly, the Lower House Constitution Committee won’t have voted on the fourth withdrawal bill yet. And that could be crucial for the Council when deciding whether or not to accelerate the normalization cycle. Although market assets suggest that higher prices could be somewhat more permanent, the EEE remains anchored at 3%, which has always been the Central Bank’s main indicator for assessing how credible its target remains. Therefore, I continue to believe that 25-basis-point hikes will continue, the TPM will end 2021 at 1.5%, and the normalization cycle will continue through Q1 2022, bringing the TPM to 2.0% by the end of that quarter.

Of course, if the information changes, so will my estimate. If there are further surprises in the CPI figures, the fourth withdrawal is approved, there are difficulties in controlling fiscal pressures in the 2022 budget, and/or inflation expectations become unanchored, 50-basis-point rate hikes would be imminent, which would further hamper economic performance in 2022—a year that would lack both the low comparison bases and the extraordinary transfers made this year. Let’s see what’s in store for us this Tuesday.

Nathan Pincheira 

Chief Economist at Fynsa