Central Bank Rate Drop

CHILE - In Brief 09 Jun 2019 by Igal Magendzo

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In a quite unprecedented and surprising move, the Central Bank decided to cut the Monetary Policy Rate (TPM) by 50 bp last week, taking it to 2.5%. Pretty much every market analyst, according to Bloomberg’s Survey, expected the Central Bank to keep the rate unchanged. The same was implicit in the interest rate swaps. It is extremely unusual for the Chilean Central Bank to surprise markets in this way. According to the communiqué the intention of the interest rate cut was to “recalibrate the monetary impulse” and that “this change in the TPM will be sufficient” under the base scenario to bring inflation back to the target in the relevant monetary policy horizon (about 2 years). In our view the Central Bank is leaving the door open for further cuts, perhaps even this year, while suggesting that if the next movement is upwards it will not happen until well into next year. The Central Bank’s most recent policy actions, including Friday’s, shed some light on its reaction function in the current environment. First, while increases in TPM tend to be gradual, reductions can be more abrupt. Second, while increases are announced, cuts can come as a surprise. The “recalibration” implies that the Central Bank acknowledges that the withdrawal of the previous monetary stimulus was excessive even under the macroeconomic conditions that prevailed when the cycle of increases started. According to the communiqué, inflationary pressures were lower than those estimated at the time, as was the neutral interest rate. These “mistakes” raise questions about the Bank’s technical capacity but reaffirm its eagerness to amend them when they are identified. The estimation of the effect of immigrat...