Chile’s Peso Plunges on Central Bank Plans to Buy $12 Billion

Chile's Central Bank President Jose De Gregorio
Chile's Central Bank President Jose De Gregorio. Photographer: Nelson Ching/Bloomberg

Chile’s peso fell the most in two decades and bond yields rose after the central bank said it will buy $12 billion in the foreign-exchange market, joining other Latin American nations in a bid to offset the dollar’s decline.

The peso declined 4.6 percent to 488 per U.S. dollar from 465.75, the steepest drop since June 1989 when Augusto Pinochet’s military dictatorship was coming to an end. Central bank President Jose De Gregorio unveiled a plan yesterday to buy $50 million a day from Jan. 5 until Feb. 9.

Chile joins other emerging nations in a battle that even De Gregorio has signaled risks being more expensive than it is helpful as the Federal Reserve pumps $600 billion into the U.S. economy while keeping its benchmark interest rate near zero. Before today Chile’s peso had gained 17 percent against the U.S. dollar since the end of June, second only to the Australian dollar among global currencies, as surging copper prices boost trade prospects of the world’s biggest producer.

“This is the biggest exchange rate intervention that has been announced in our country,” Finance Minister Felipe Larrain told reporters in Santiago. “It seems to us to be a measure that is on the right track and that will have an impact on the exchange rate.”

Bond yields climbed the most in more than a year. The yield on a basket of 20-year inflation-linked bonds rose 24 basis points, or 0.24 percentage point, to 3.38 percent. The yield on 10-year inflation-linked bonds gained 25 basis points to 3.20 percent.

Yields will probably rise as the bank sells $10 billion in bonds to mop up the extra money, De Gregorio told reporters today in Santiago.

Swap Rates

Short-dated inflation-linked swap rates plunged as traders price in the likelihood of faster price rises. The one-year inflation-linked swap rate fell 13 basis points to 0.61 percent while the three-month rate fell 35 basis points to 3.25 percent.

“The market will price in higher inflation straight away,” said Aldo Lema, an economist at Banco Security. “It may begin discounting inflation nearer to 4 percent than 3 percent this year.”

The central bank targets 3 percent inflation over two years with a 1 percentage point margin of error.

De Gregorio warned last month that the real exchange rate, a measure of the peso’s strength against other currencies that discounts inflation, was near the strongest level coherent with fundamentals.

Record Copper

The peso, the best-performing Latin American currency tracked by Bloomberg last year, rose to the strongest level since May 2008 yesterday as copper traded to a record in New York. Copper accounts for more than half of Chile’s exports.

In a statement on its website yesterday, the bank said it aimed to “soften the effects” of the appreciating peso on the economy. The bank will reassess the pace of its dollar purchases after Feb. 9 and expects to buy the full $12 billion by the end of the year, it said.

“It’s not a hard barrier: it’s a signal,” said Alberto Ramos, an economist at Goldman Sachs Group Inc. in New York. “If the currency appreciates from here because copper continues to rally and the dollar weakens, I think they’ll live with it.”

De Gregorio said in August that the bank would only intervene if the benefits outweighed the costs.

In yesterday’s statement the bank warned that “accumulating international reserves brings with it significant financial expense, associated with the differential between the return on investment and the cost of financing it. The level proposed for the international reserves is coherent with the central bank’s long-term financial sustainability, although the leeway is limited.”

Expressed Doubts

In a speech to the Chilean Senate last month, De Gregorio expressed doubts about the effectiveness of measures taken by countries in Asia and Latin America to fight dollar weakness.

“In the end what it’s about is affecting the real exchange rate and the evidence in this respect shows that, on average, there isn’t a clear relationship between the level of countries’ interventions and the exchange rate,” he said, according to a transcript of his remarks posted on the bank’s website.

The Chilean central bank has raised its benchmark interest rate for seven straight months as the economy expands at its fastest pace in five years, accumulating a 2.75 percentage point increase to 3.25 percent that further pressured the currency.

Lehman Collapse

Chile’s central bank last bought dollars to weaken its own currency in 2008, when it started buying $8 billion in $50 million-a-day increments. It abandoned the plan following the collapse of Lehman Brothers Holdings Inc. having bought $5.75 billion and weakened the peso by 19 percent, more than any emerging-market currency except the Icelandic krona.

The bank justified this year’s move by saying it wanted to raise its level of reserves to levels comparable with those of similar economies. Building reserves now will help it deal with a possible deterioration in the international economy, it said, citing financial tension in Europe and high levels of unemployment in developed economies.

On Dec. 21, De Gregorio said the bank was “pretty content” with its reserves, which were “relatively adequate” compared with its peers.

The effectiveness of measures to stem the peso’s gains may help policy makers decide whether to raise rates at their next meeting on Jan. 13. While the bank expects to keep increasing rates, policy makers debated pausing when they met last month and, according to minutes published yesterday, plan to discuss it again in coming meetings.

“If this helps, they’ll probably raise again,” said Ramos. “If despite this the currency keeps gaining, they’ve got one tool left.”

Peru, Colombia, Brazil

Peru’s central bank on Jan. 1 extended reserve requirements for banks to their overseas units as it seeks to stem short-term capital inflows from increasing volatility in the sol. Colombia’s central bank plans to buy $20 million a day until March 15 and the government said on Oct. 29 it would buy as much as $3.7 billion in the currency forwards market.

Brazil tripled to 6 percent in October a tax on foreign purchases of fixed-income securities in a bid to contain the real’s gains. It may take new measures to curb the strength of the real, Finance Minister Guido Mantega said last week.

De Gregorio earned his doctorate in economics at the Massachusetts Institute of Technology, where he studied under Rudiger Dornbusch, U.S. Federal Reserve Chairman Ben Bernanke and Nobel Prize winner Paul Krugman. He once said Dornbusch, best known for a 1976 paper showing that exchange rates often “overshoot” their equilibrium in the short term, was the economist that most influenced him.

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