Chile Bucks Latin America Trend in Holding Key Rate at 5%

Chile’s central bank kept benchmark borrowing costs unchanged today for the 14th consecutive month as faster-than-expected economic growth prevents policy makers from joining Brazil, Mexico and Colombia in cutting rates.

The bank board, led by the institution’s President Rodrigo Vergara, held the benchmark rate at 5 percent, as forecast by all 20 analysts surveyed by Bloomberg. The bank last changed borrowing costs in January 2012 with a quarter-point reduction that surprised economists.

Chile has little room to follow regional peers in cutting rates as long as economic growth doesn’t plummet from the 6.7 percent rate registered in January, even as inflation remains at the lowest in the region. Traders in the interest rate swap market forecast borrowing costs will remain on hold through at least June.

“Domestic threats such as faster-than-expected economic growth are weighing more than they did before,” Banco Bilbao Vizcaya Argentaria SA economist Felipe Jaque said by phone from Santiago on March 13. “There isn’t much space to change the rate, although data on economic activity in coming months will be important.”

Two-year rate swaps, which reflect traders’ views of average borrowing costs, rose four basis points, or 0.04 percentage point, from the end of last month to 5.22 percent today. That indicates traders expect robust growth to prompt a quarter-point rate increase by September, according to calculations by Banco de Chile.

Inflation Slows

While growth has exceeded analysts’ forecasts for six consecutive months, easing inflation is keeping pressure off the central bank board from raising rates, Nathan Pincheira, a senior economist at Banchile Inversiones, said by phone from Santiago March 12.

Inflation slowed to 1.3 percent in February from 1.6 percent in January, and compared with 3.55 percent in Mexico, 1.83 percent in Colombia and 6.31 percent in Brazil. Price-growth has remained below the central bank’s target range of 2 percent to 4 percent for three months.

Two-year breakeven inflation, which is derived from the difference between nominal and inflation-linked yields on swaps, declined 11 basis points to 2.86 percent today from the end of last month.

“The central bank needs stronger evidence that inflation could be faster than the central bank wants for it to make changes,” Pincheira said. “Evidence just needs to be firmer.”

Growth Outlook

Policy makers eventually need to tighten monetary conditions as economic growth rates threaten to put pressure on inflation, Alfredo Coutino, Latin America director at Moody’s Analytics, said March 13.

Gross domestic product in the world’s top copper producer expanded 5.6 percent last year and will climb 4.8 percent in 2013, the fastest growth among major Latin American economies after Peru, according to analysts polled by Bloomberg.

Brazil, which is Latin America’s largest economy, has cut its key interest rate 3.25 percentage points in the past year to shore up lagging growth, while Mexico last week reduced borrowing costs for the first time since 2009. Colombia has reduced rates six times since June.

While cutting rates in Chile would be a proactive step to protect against an expected economic slowdown later this year, policy makers ruled out that option last month amid concern that inflationary pressures would increase, according to minutes of the Feb. 14 meeting posted on the central bank website.

“Domestic risks have gained importance, at least in the short term,” Vergara said on March 6 in a speech in Santiago. “Output and demand indicators exceeded forecasts over the last year.”

‘Sooner or Later’

Unemployment fell to 6 percent in the three months through January from 6.6 percent the year before as wages expanded 4.3 percent above inflation in the first month of 2013 from the year earlier, according to government data. Retail sales surged 9.5 percent in January after climbing 8.8 percent in 2012.

“Domestically, output and demand indicators have exceeded forecasts,” the central bank said in a statement accompanying today’s decision. “Economic activity reflects improvements in mining, while demand growth, driven by investment, is outpacing GDP. The labor market is still tight.”

Chile’s peso has responded to the economic growth by strengthening 3.2 percent against the U.S. dollar in the past 12 months, the best performance among major Latin American currencies tracked by Bloomberg. The peso fell 0.2 percent to 471.44 per dollar today.

“Sooner or later inflation is going to respond positively to the pressures coming from fast economic growth,” Coutino said by phone from West Chester, Pennsylvania. Far from following its regional peers and easing borrowing costs, “Chile is one of the most likely candidates to hike rates.”

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