Volatility is everywhere

CHILE - Report 20 Oct 2021 by Igal Magendzo and Robert Funk

The Monthly Index of Economic Activity (IMACEC) in August again surprised on the upside. We are facing a level of activity unlikely to be sustainable in the long term, and which will continue to exert inflationary pressures. Consumption has played a central role in increasing demand, as a result of both fiscal stimuli and withdrawals of pension savings. The likelihood of an additional withdrawal seemed low until recently, but no longer does. In contrast to consumption, investment remains sluggish.

Retail sales continued to grow in August, although with a slight deceleration. Services were the most dynamic sector, which is indicative of a reallocation of household spending. Even with higher national mobility figures, manufacturing had a hard time joining the substantial advance of other sectors, such as commerce and services. Throughout 2021, mining has not contributed at all to economic growth.

Labor market figures showed favorable results in August. The labor force increased slightly less than employment did, so the unemployment rate fell again. Unemployment continued to trend downwards, falling from 9.5% to 8.9%, and reaching its lowest since Q1 2020. Nevertheless, employment is still 793,000 below pre-pandemic levels. August data on wages showed a slowdown, especially in real terms. This sheds some doubt on the existence of inflationary pressures coming from labor costs, at least at an aggregate level.

With a monthly variation of 1.18%, September’s CPI widely exceeded market expectations. The 12-month variation reached 5.3%, its highest since November 2013. The various measures of core inflation showed somewhat smaller monthly increases. Transfers to households have led to demand pressures in a context of still-restricted supply, and the idiosyncratic depreciation of the peso is reflected in the prices of tradable products. With a depreciation of more than 10%, the peso is one of the most depreciated currencies in the world so far this year.

Inflation is above 5%, 2-year inflation expectations have moved slightly above 3% (which is unusual), 2 to 3-year forward inflation swaps are above 3%, global inflation is increasingly worrisome, local demand pressures continue and the peso has continued to depreciate idiosyncratically. Moreover, the risk of a fourth withdrawal calls for preemptive action. In this context, the Central Bank announced a surprising 125 bp hike in the TPM. This move seems reasonable from the point of view of the theory of optimal monetary policy. But the Bank’s communiqué did not offer much in the way of forward guidance. It seems that the Central Bank is sending a clear message to politicians regarding what will happen with monetary policy if transfers to households continue.

Although for months public opinion polls have indicated that the presidential race was essentially a competition between Gabriel Boric and Sebastián Sichel, the latter’s poor debate performance and some unforced errors, along with accusations of dodgy campaign financing, have hurt Sichel’s position. Although this week one poll gives José Antonio Kast the advantage and another shows Boric in first place, the reality is that with only five weeks to go to the first round, the election outcome remains uncertain.

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