Chilean Central Banker Sees Possibility of Two More Rate Cuts

Chilean central bank director Pablo Garcia said policy makers have room to cut rates once or twice more as the economy grows at the slowest pace in four years. Traders are pricing in only one more reduction.

“There is space for rates to fall further,” Garcia said in an interview in Santiago yesterday. “We knew the third quarter was going to be weaker in terms of growth and that was considered within our options.”

The central bank has cut its key interest rate once since Sept. 3, when policy makers in their quarterly monetary policy report said two or three more reductions were likely. With inflation expectations stable at the target of 3 percent in two years’ time, that forecast remains the bank’s “base scenario,” Garcia said. The bank has reduced borrowing costs seven times in the past year, pushing the key rate to 3.25 percent.

Traders in the swaps market expect policy makers to keep rates on hold in October and cut once more in November to 3 percent, according to Bloomberg calculations. The bank will probably begin raising rates again in April of next year.

Central bank President Rodrigo Vergara said last week that the series of rate cuts was coming to an end, forecasting a gradual recovery in economic growth starting in the fourth quarter.

“The surprise is that Garcia signaled one or two more cuts,” said Marcos Buscaglia, the chief Latin America economist at Bank of America Merrill Lynch. “We see the risk of one additional cut from current levels.”

Slowing Down

Chile’s Imacec index, a proxy for gross domestic product, rose 0.3 percent from the year earlier, the central bank said yesterday, below the 0.6 percent median estimate of analysts surveyed by Bloomberg. Growth was the weakest since the aftermath of an earthquake that devastated the center-south of the country in February of 2010.

“The Imacec data is bad, there is no denying it, but it doesn’t change our medium-term view,” Garcia said. “I don’t see any reason to modify our forecast for 3 percent to 4 percent growth next year.”

Manufacturing output fell 4.9 percent in August from the year earlier, the National Statistics Institute said on Sept. 30. Retail sales gained 1.7 percent over the same period and mining production stagnated.

Policy makers including Garcia cut their growth forecast for 2014 for the fourth consecutive quarter on Sept. 3 to 1.75 percent to 2.25 percent, down from a previous estimate of 2.5 percent to 3.5 percent.

Rebound Forecast

The slowdown in growth led the government to announce an “expansionary” budget for next year. Spending will rise 9.8 percent from what was budgeted for 2014, led by a 27.5 percent jump in investment.

The spending plan will help lift growth to about 3.6 percent, Finance Minister Alberto Arenas said.

“It is very difficult to think that Chile will grow less in 2015 than this year,” Garcia said. “As the global scenario clears up and the macro stimulus is felt, that should support a recovery in confidence and give space for activity to grow between 3 percent and 4 percent.”

GDP expanded 1.9 percent in the second quarter from a year earlier, down from 2.4 percent in the first quarter and compared with 4.1 percent last year and 5.4 percent in 2012. The slowdown was led by a slump in investment in the mining industry.

Inflation Threat

This year’s acceleration in inflation won’t prevent further rate cuts as expectations remain anchored at 3 percent in two years, Garcia said. Prices rose 4.5 percent in the 12 months to August, unchanged from the month before and up from 1.5 percent in October 2013.

In the minutes of last month’s monetary policy meeting, one policy maker warned that fueling expectations of rate cuts could undermine the peso and stoke inflation.

The peso has fallen 16.6 percent against the dollar in the past 12 months, the worst-performing emerging market currency after the Argentine peso and the Russian ruble.

“I am comfortable with the base scenario in which we grow more next year and inflation returns to the target,” Garcia said. “We expect a rebound in confidence and the expansion of economic activity.”

Before it's here, it's on the Bloomberg Terminal.