As Chile's Growth Potential Ebbs, Traders See Faster Rate Hikes

  • Yields surged after the central bank's monetary-policy report
  • Lower potential growth estimate implies narrower output gap

Chilean policy makers are ratcheting down their estimates for how fast the economy can grow without stoking inflation, spurring bets that the Andean country will raise benchmark interest rates as early as this year.

Lowering the so-called potential growth rate to 3.5 percent from as high as 4.5 percent means policy makers believe the economy has less room to rebound from the slowest expansion in years without fueling inflation. The change in view comes after central bankers debated, for the first time in three years, raising rates last month as the collapse in copper prices pushes the currency lower and the Federal Reserve gets closer to lifting U.S. borrowing costs.

Chile’s potential growth is slower than it was during the “commodities boom, so there isn’t the spare capacity,” Capital Economics economist Edward Glossop said from London. “That works in favor of rate hikes sooner.”

Benchmark borrowing costs are rising at the quickest pace in more than four years, with the yield on 10-year inflation-linked bonds climbing 0.19 percentage point since the bank published its monetary-policy report on Sept. 1 to 1.58 percent.

Chile has had the lowest inflation-adjusted interest rates in the region since September as policy makers bet sluggish growth would tame inflation that exceeds their target of no more than 4 percent. The latest estimates suggest the central bank now expects it needs higher rates to do the job.

The bank raised its forecast for inflation this year to 4.6 percent from 3.4 percent and for next year to 3.7 percent from 3.1 percent as it reduced the potential growth rate. Data released Monday showed Chile growing at an annual pace of 2.5 percent in July, less than half the average for 2010 through 2013. On Tuesday, the statistics institute said inflation accelerated to 5 percent in August, the fastest since November.

“We don’t think there’s room to raise rates this year, but if we see bad inflation numbers for August and September there could be a hike in October,” said Felipe Alarcon, the chief economist at EuroAmerica in Santiago. “It’s the logical consequence of what the bank is saying.”

The central bank has kept its benchmark rate unchanged at 3 percent since October last year after cutting from 5 percent as growth slowed.

Central bank minutes show policy makers are concerned that in the short term, the depreciation of the currency will lead to faster price rises. The peso has weakened 13 percent this year after copper, which accounts for half Chile’s exports, fell to six-year lows.

Two-year rate swaps, which reflect rate expectations, rose 0.26 percentage point in a week to an 18-month high of 3.99 percent on Tuesday. The swaps are up 0.47 percentage point from a month earlier.

Central bank President Rodrigo Vergara said Thursday that the bank is likely to raise rates twice in the next 12 months, and again in the following six months, each time by a quarter percentage point. 

Traders are now significantly more hawkish, with the swaps market showing bets on as many as six quarter-point rate increases by the end of next year, according to Jorge Selaive, the chief economist for Banco Bilbao Vizcaya Argentaria in Santiago.

“I’m not sure the central bank expected that reaction and I suspect they didn’t,” Selaive said. “We’ve had a week of rising swaps and they’re still rising.”

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