Chile Raises Interest Rate for Second Time This Year to 3.5%

  • Quarter-point increase responds to inflation, labor market
  • Annual inflation seen above target range for part of 2016

Chile raised borrowing costs for the second time this year following a pause in November, as central bankers continue to see inflation in the South American country running above the 4 percent target in 2016.

Policy makers, led by bank President Rodrigo Vergara, raised the benchmark interest rate by a quarter point to 3.50 percent Thursday, as forecast by 12 of 26 economists surveyed by Bloomberg. Fourteen expected no change. The move came a day after the U.S. Federal Reserve boosted rates for the first time in more than seven years Wednesday, and hours after Mexico raised its key rate to 3.25 percent.

"Inflation could exceed 4.5 percent in the next two months and given that it could move away from the target range again and that the exchange rate has remained high in the past few weeks, the central bank hiked," Andres Osorio, economist at Credicorp Capital in Santiago, said after the decision.

At the same time, by introducing a hawkish bias in its decision, "the bank suggests that even if additional raises could come, they will be at a slower than expected pace," Osorio added. Credicorp Capital believes the central bank will hike twice more in 2016, two 25 basis-point hikes, leaving the rate at 4 percent, he said.

The peso has declined 14 percent against the dollar in 2015 -- eighth worst performance among 24 major emerging market currencies tracked by Bloomberg -- and has traded near a 12-year low over the last month.

Annual inflation is down from 5.7% in October 2014 to 3.9% last month though central bankers see a pick-up ahead.
Annual inflation is down from 5.7% in October 2014 to 3.9% last month though central bankers see a pick-up ahead.

A slowdown in inflation back to the central bank’s 2 percent to 4 percent target range in November will provide only a temporary respite for policy makers, Vergara said last week, forecasting that consumer price increases would quicken again in the next few months. After a quarter-point rate increase in October, annual inflation last month unexpectedly slowed to 3.9 percent, the first print within the target range since March 2014.

"Unfortunately, all of our projections and the market forecasts show that inflation will go back above 4 percent in coming months and it will stay there for several months during 2016," Vergara said Dec. 10. Over the long-term, "inflation expectations remain absolutely anchored in our 3 percent target."

With inflation expectations two years ahead anchored at the 3 percent mid-point of the target range, the central bank has vowed to retain monetary stimulus amid economic weakness, saying that the key rate won’t reach the neutral level of 4.5 percent to 5 percent any time soon.

"In September’s quarterly inflation report we spoke about two or three rate increases and that scenario hasn’t changed today," Vergara told El Mercurio newspaper Nov. 29. The bank is set to release its new quarterly inflation report Dec. 21. "We will have to see if there is a change in that diagnosis," he said.

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