The big debate today is about local inflation. Who would have thought, after many years in which this was not an issue? In fact, not long ago, inflation was expected to arrive, whether due to exchange rate issues, closing gaps, rising oil prices, etc., but it never did. If you don't believe me, check the reports from local (and even foreign) research departments in the years leading up to the pandemic and you will see that this was the case. It wasn't just in Chile: around the world, it was a puzzle as to why, with economies growing, high employment, and rising wages, prices remained unchanged.

"We're not in Kansas anymore," and today, for various reasons, inflation is THE issue. Locally, almost everything conspires to that end: strong local recovery in several sectors (but not all), currency depreciation, rising oil prices, the possibility of other energy prices increasing, shortages of various goods due to disruptions in international supply chains, significant increases in maritime freight prices, withdrawals from pension funds, transfers from the state, etc. In July, the Central Bank raised its estimate to 4.4% for the end of the year, and everyone (myself included) thought it was exaggerating. Today, it seems to be a conservative estimate, especially because since that macroeconomic framework was established, a lot, perhaps too much, has happened.

The year-on-year price variation reached 4.5% in July, after a surprising 0.8% month-on-month increase in that month, raising many alarms. I agree that not all inflation comes from demand, which makes a big difference when talking about what brings us together, but a significant part of it does. And if we combine that excess demand with the shortage of supply, it is 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 bp hike, bringing the MPR to 0.75%. The message conveyed in that statement and in the minutes was received by the market as "less hawkish" than previously seen, with some even predicting that there would not be a series of hikes and that the entire process would be carried out with caution. The data since then, the extension of the IFE, the possibility of a fourth withdrawal, the exchange rate depreciation, etc., have changed the market's opinion and, I have no doubt, that of the Council. Thus, from caution to urgency, it is argued that the Governing Body would surprise even at its August meeting, with a 50 bp increase, and it is not ruled out that these will be repeated in October and December.

Don't get me wrong. I think that scenario is entirely possible. However, I don't think they will go through with it, at least not yet. The Monetary Policy Meeting will be held on August 31, prior to the presentation of the IPoM on September 1. Obviously, that meeting will consider the scenario in that IPoM and not the "current" one for July. Therefore, at that time, we will not have additional inflation figures, perhaps some preliminary growth figures for July, but, more importantly, the vote in the Lower House Constitution Committee on the fourth withdrawal will not yet have taken place. And that could be vital for the Council when deciding whether or not to rush the normalization cycle. Although market assets predict 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 the 25 bp hikes will continue, the MPR will end 2021 at 1.5%, and the normalization cycle will continue during 1Q22, bringing the MPR to 2.0% by the end of that quarter.

Of course, if the information changes, so will my estimate. In the event of new surprises in the CPI, approval of the fourth withdrawal, difficulties in controlling fiscal pressures in the 2022 budget, and/or a decoupling of inflation expectations, 50 bp increases would not be long in coming, which would further hamper economic performance in 2022, which would not benefit from low bases of comparison or the extraordinary transfers made this year. Let's see what happens on Tuesday.

Nathan Pincheira 

Chief Economist at Fynsa