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Chilean Swap Rates Tumble on Central Bank’s Surprise Reduction

Chilean swap rates declined to a five-month low after the central bank unexpectedly cut the benchmark interest rate yesterday, citing the prospect of the Federal Reserve maintaining limits on U.S. borrowing costs.

Two-year swap rates decreased 14 basis points, or 0.14 percentage point, to 4.45 percent at 1:41 p.m. in Santiago, the lowest level since May 21. The peso depreciated 0.6 percent to 496.87 per dollar at the close of trading after rallying yesterday to a four-month high.

Policy makers lowered the target lending rate by a quarter-percentage point to 4.75 percent in the first reduction since January 2012, pointing to the outlook for slower inflation. The Fed spurred demand for higher-yielding assets in emerging markets when it said last month it would maintain $85 billion of monthly bond purchases to keep U.S. rates low.

Chile’s “central bank acted because of concern that tapering will be delayed for a long time,” Sebastian Ide, the head of rates trading at Banco de Chile in Santiago. “It’s this concern about the rate differential.”

Traders are projecting today a benchmark rate of 4.5 percent by February, Ide said. He expects the bank may cut borrowing costs to as low as 4.25 percent.

Inflation eased to 2 percent in September, the slowest pace in Latin America after Ecuador, while economic growth has weakened for three consecutive quarters. The slowdown led the central bank to cut its 2013 growth forecast last month to 4 percent to 4.5 percent from 4 percent to 5 percent.

Break-Even Rate

The five-year break-even rate, a gauge of traders’ inflation projections for the period based on the difference between fixed and inflation-linked bond yields, dropped to 2.60 percent, the lowest since May.

“Inflation has evolved below projections, remaining in the lower part of the tolerance range, while market expectations foresee a slower normalization towards 3 percent,” the central bank said yesterday.

The gap between one- and two-year swaps narrowed three basis points to seven basis points and the spread between two-and 10-year swap rates rose six basis points to 79 basis points. While the swaps curve steepened, it was still the flattest in the region, signaling that investors see interest rates at the top of their long-term range.

The peso will probably weaken toward 500 to 510 per U.S. dollar as reduced interest rates make the currency less attractive to international investors, according to Alejandro Cuadrado, a foreign-exchange strategist at Banco Bilbao Vizcaya Argentaria SA in New York.

“We’re looking for the rates compression to be gradually incorporated into the currency,” Cuadrado said. “We’re seeing some of the adjustment already, and it should continue in the near term.”

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