Chile Raises Rate to 2.5% on Rising Demand, Inflation Forecasts

Chile’s central bank raised its overnight interest rate for a fourth straight month as inflation expectations rise on rebounding domestic demand and the fastest economic growth since 2005.

The five-member policy board, led by bank President Jose De Gregorio, raised the benchmark rate by a half point to 2.5 percent today, matching the forecast of all 17 economists surveyed by Bloomberg.

The recovery of South America’s fifth-biggest economy from last year’s recession and February’s 8.8-magnitude earthquake is removing slack in the economy and will likely put pressure on consumer prices, said Rodrigo Aravena, an economist at Banchile Inversiones. By the time the so-called output gap closes next year, policy makers want a rate that is closer to a level that neither stimulates nor stymies growth, Aravena said in a phone interview from Santiago.

“The bank is showing the market that the interest rate continues to be extremely expansive,” he said. “It is clear there was no other option but to increase the rate,” citing the improved labor market, internal demand and rising inflation expectations.

The central bank last week raised its 2010 growth forecast to a range of 5 percent to 5.5 percent, up from 4 percent to 5 percent forecast in a June report. That would be the fastest growth since a 5.6 percent expansion in 2005. The bank also raised its year-end inflation forecast to 3.9 percent, near the top of its target range.

Growth Trajectory

Output and demand information has not changed since the central bank developed the quarterly report, policy makers said in a statement accompanying their decision today.

Chile’s economic expansion could cause actual gross domestic product to match potential GDP in 2011, De Gregorio said in a Sept. 12 interview in Basel, Switzerland

“Our measure of the output gap, which is current output minus full capacity output, is about 1 percent,” he said. “It was much bigger before the earthquake.”

Central bank models consider 5 percent to 6 percent to be a neutral interest rate for Chile, De Gregorio said in the interview.

Industrial production has started to recover in Chile since the Feb. 27 temblor damaged roads, factories and ports in a swathe of the country that accounts for about 17 percent of the country’s output. Year-on-year output grew for a third month in July, expanding 3.3 percent.

Rate Horizon

Chile’s gross domestic product expanded 1.5 percent in the first quarter and 6.5 percent in the three months through June, the fastest rate of quarterly growth since the second quarter of 2005. GDP rose a greater-than-expected 7.1 percent in July on growth in the retail, transport, communications and energy industries

The peso, whose 6.5 percent increase against the U.S. dollar over the past three months is the most among Latin American currencies tracked by Bloomberg, closed down 0.7 percent today to 498.25. The Ipsa stock index, which has gained 34.4 percent this year, fell 0.2 percent.

A 2.5 percent interest rate still is expansive, Matias Madrid, chief economist at Banco Penta, said in a telephone interview from Santiago.

“It’s still valid to keep raising by 50 points in the next meeting,” he said, adding that policy makers may slow the pace of rate increases in the final quarter of the year.

Detection

Chile’s overnight rate will reach 3.5 percent in December before increasing to 5 percent in August 2011, according to the median estimates of 36 economists in a monthly central bank survey.

“The Board will continue to reduce the current significant monetary policy stimulus at a pace that will depend on the unfolding of domestic and external macroeconomic conditions,” the central bank said in today’s statement.

Economists in the survey estimate annual inflation will reach 3.3 percent in both December 2010 and August 2011. Policy makers target annual inflation of 3 percent plus or minus one percentage point.

Consumer prices fell 0.1 percent in August from July as duties on financial transactions fell, increasing 2.6 percent from the previous year, Chile’s statistics institute said in a Sept. 8 report.

“We don’t react to breaking news but we do process it to detect medium-term trends,” De Gregorio said in a Sept. 8 speech in reference to August consumer price data. “The dilemma isn’t whether the monetary rate should continue increasing or not, but at what rate.”

To contact the reporter on this story: Randy Woods in Santiago at rwoods13@bloomberg.net

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