Chile’s Vergara Sees Higher Rates After Output Gap Undershoots

Chile’s central bank President Rodrigo Vergara reiterated that policy makers would probably start to raise interest rates around the end of the year after over-estimating the output gap in the economy.

Economic growth is picking up and inflation is “not that far out of the range” targeted by the central bank, Vergara said at the Bloomberg Americas Monetary Summit in New York.

“We expect to start normalizing rates by year end or the beginning of next,” Vergara said. It is “very much data dependent. However, we have also said that the stance will remain accommodative for a long period of time, we don’t expect it to go to a neutral rate very rapidly.”

A decline in the peso over the past two years has had a bigger impact on inflation than anticipated because there was less slack in the economy than policy makers had expected, Vergara said. Growth picked up the fourth quarter and probably accelerated again in the first three months of this year, he said.

The central bank left its key rate at 3 percent on April 16 for a sixth consecutive month after cutting borrowing costs eight times in the year through October.

Consumer prices rose 4.2 percent in March from the year earlier, compared with the bank’s 2 percent to 4 percent target range. Core inflation, which excludes fuel and produce, has accelerated for 21 of the past 22 months, reaching 5.5 percent in March.

Inflation has “been quite persistent and that’s been a concern for us, although we expect it to go to the range relatively soon,” Vergara said.

Inflation Outlook

Policy makers last month raised their inflation forecast for this year to 3.6 percent from a previous estimate of 2.8 percent in December.

They also said inflation will be 3.2 percent by December 2016, the highest forecast for the last three months of the two-year outlook in 11 years. Inflation expectations remain anchored for the two years ahead, according to a poll published by the bank on April 10.

Expectations “are very well anchored at our target and while that is the case we are comfortable with monetary policy,” Vergara said.

The main factor behind the persistence of faster inflation is the depreciation of the peso, Vergara said on April 10. The labor market has also remained tighter than forecast, keeping nominal wage growth at 7.1 percent in February.

“We probably overestimated the output gap or slack in the economy and one of the reasons that makes us think so is precisely what happened in the labor market,” Vergara said.

The jobless rate reached 6.1 percent in the three months through February, unchanged from the year earlier and up from a low of 5.7 percent at the end of 2013.

Welcome Decline

The decline in the peso was expected and welcome given the drop in commodity prices, Vergara said. The currency has recently stabilized and even appreciated a little, he said.

There also are signs the labor market is beginning to weaken, with job creation falling and the quality of jobs also declining, Vergara said.

“We expect some weakening in the jobs market during this year, not that much, but some,” he said.

Chile’s economy expanded 1.8 percent in the fourth quarter from the year earlier, the fastest pace in five quarters. Growth slowed to 1.9 percent over all of last year from a revised 4.2 percent in 2013, the central bank said on March 18.

The central bank maintained its growth forecast for 2015 on March 30 at 2.5 percent to 3.5 percent, after cutting it in five consecutive monetary policy reports.

“We might have a couple of years of low growth, but then it will pick up,” Vergara said. “The economy is adjusting” to weaker commodity prices and a lower peso, with “production moving to other tradable sectors.”

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