Chile Swaps Rise as Central Bank Debates Interest-Rate Increase

  • Policy makers split on whether discussion sent wrong message
  • Central bank board members blamed inflation on weak peso

Chilean rate swaps rose to the highest in more than a year after minutes showed central bank policy makers this month discussed raising their benchmark rate for the first time since May 2012.

The one-year swap rate climbed 0.09 percentage point to 3.41 percent at 12:18 p.m. in New York, the highest since July last year, indicating traders expect the central bank to lift the benchmark rate twice in the next 12 months. The rate has increased 0.35 percentage point in the last six weeks and the two-year rate has risen 0.45 percentage points in the same period.

The notion of even discussing a rate increase provoked a dispute among policy makers, who are not identified by name in the minutes. One of the five central bank board members warned that even to think about the quarter-point rise risked sending the  “premature and possibly wrong” message that the bank was preparing the ground for a rate increase in the near term. Another policy maker responded that it was important to discuss that to show the bank’s commitment to its inflation target. All the board members shared a concern that the slide in the peso meant faster inflation in coming months.

“The central bank is focusing on inflation and is going to do whatever it takes to prevent it taking off or remaining at such high levels,” said Nathan Pincheira, an economist at Banchile Inversiones in Santiago. “It’s saying to the market that the option is there and that they can take it at any time.”

Pincheira says the central bank is more likely to try to slow the depreciation of the peso by using swaps or selling bonds payable in dollars than it is to raise rates. Chile’s peso weakened 3 percent this month and reached a new 12-year low as concerns that demand from China is slowing pushed the price of its main export, copper, down to the lowest since 2009.

Chile’s central bank aims to have expectations for inflation in two years’ time at 3 percent, with a one-percentage point margin of error on either side. Inflation hasn’t slowed below 4 percent since March 2014, yet central bank surveys show expectations remain anchored at 3 percent. 

“One of the central bank’s greatest assets is its credibility, which allows it to control inflation by anchoring expectations,” Pincheira said.