Chile's Central Bank Leaves Rate on Hold at 0.5% After Economy Contracts

Chilean central bank President Jose De Gregorio left the country’s benchmark interest rate at a record low 0.5 percent as the economy recovers from the deadly February earthquake.

The bank’s decision matched the forecasts of 20 of 25 economists surveyed by Bloomberg; the others predicted a quarter-point increase. The bank changed the language in its statement today to say that “the moment for beginning the process of rate normalization approaches.”

Central bank economists said in a report last night that the impact of the Feb. 27 earthquake was greater than they had initially anticipated. Economic activity fell 2.8 percent in March from a year earlier and 6.6 percent from February because of damage to ports, roads and factories, while industrial output shrank 17 percent from a year earlier.

“Given the deterioration of the external scenario and the sharp decline in activity in March, the bank is justified in waiting until June,” said Rodrigo Aravena, chief economist at Banchile Inversiones in Santiago. “It would be pretty hard to justify waiting beyond June.”

De Gregorio cut the benchmark rate to its current level last July as inflation plunged and Chile worked to fight off a recession. Chile’s economy probably grew 1.4 percent in the first quarter of this year from the same period in 2009, the central bank’s economists said in yesterday’s report.

The bank lowered its growth forecast for this year by a quarter percentage point to 4.25 percent to 5.25 percent following the earthquake.

Swaps Market

Traders in Chile’s interest-rate swaps market had increased bets that the bank would raise the overnight rate after minutes from its prior meeting, published April 30, revealed that policy makers had discussed lifting rates last month.

The central bank may raise borrowing costs to 2.5 percent at the end of this year as inflation accelerates to 3.5 percent, according to the median estimate of 38 economists in a central bank survey released May 10. The bank targets 3 percent annual inflation over a horizon of two years.

“The central bank is going to start a process of gradual withdrawal of monetary stimulus,” Aravena said. “A 2.5 percent rate at the end of this year would still be positive for growth. Above 5 percent would be becoming less expansive, but we won’t reach that level until late 2011.

Annual inflation was 0.9 percent in April.

Inflation Outlook

Immediate inflation expectations have fallen in the past week. The pace of consumer price increases implied by the inflation forwards market for May dropped to 0.25 percent today from 0.39 percent on May 6, taking the implied annual pace to 1.35 percent from 1.57 percent, according to Banco Santander SA prices. The forwards market implies inflation will end the year at 3.44 percent.

“Inflation is far below the bank’s target but has been on an increasing trend since the beginning of the year,” said Alfredo Coutino, director for Latin America at Moody’s Economy.com Inc. in West Chester, Pennsylvania.

The earthquake, the fifth-largest in a century, caused almost $30 billion of damage, equal to about 17 percent of the country’s gross domestic product, according to President Sebastian Pinera. The temblor smashed infrastructure including ports, roads and factories.

At the same time, consumer spending has been rising as joblessness declines and Chileans repair their homes and send aid to the devastated areas.

Economic Growth

South America’s fifth-largest economy suffered its deepest recession in a decade last year, opening up a gap between its actual GDP and its potential output. The quake damage will help narrow that deficit, which could stimulate faster inflation, central bank Chief Economist Pablo Garcia said in an April interview.

“Inflation will rise to about 4 percent and then start to fall, passing 3.7 percent at the end of the year and converging on the target next year,” Garcia said. “That’s our scenario, which isn’t that different from private forecasts.”

Chile’s economy was gathering momentum before the Feb. 27 earthquake. GDP expanded 2.1 percent in the fourth quarter of 2009 from the same period a year earlier, the first year-on-year quarterly growth since the end of 2008. In January, the economy expanded at the fastest pace in 16 months, boosted by growth in retailing, auto sales, and the power, water and gas industries.

“The region’s economies weathered the storm and are rebounding fast and there’s a need to move on monetary policy,” said Luis Arcentales, an economist at Morgan Stanley in New York.

To contact the reporter responsible on this story: Sebastian Boyd in Santiago at sboyd9@bloomberg.net

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