Since the late May monetary policy meeting, upside supply-side inflationary risks have consolidated, copper prices fell yet remain elevated, the CLP appreciation stabilized at around 7% versus 1Q24 highs, and the upbeat domestic activity dynamics seen at the start of the year expectedly softened. With medium-term inflation expectations anchored and monetary policy still restrictive, we forecast smaller sized rate cuts going forward. The Board trimmed the size of cuts in recent meetings (to 50 bps in May), and we envisage a further reduction to 25 bps this month with unchanged data dependent guidance, providing the BCCh with additional policy flexibility as it gradually approaches towards neutral (around 4% nominal).
External backdrop unchanged. In our view, growth in Chile’s main trading partners has largely evolved as anticipated by the BCCh, as inflation has also been essentially in line. In our view, the FOMC’s updated dot plot are in line with the March IPoM. Risks related to Fed repricing and heightened geopolitical tensions remain elevated.
No surprises on the domestic activity front. Non-mining activity is gradually recovering, but credit dynamics and capital goods imports continue to limit expectations of a swift rebound. Non-mining GDP grew 1.5% YoY in 1Q24 (up from 0.8% in 4Q24), and activity levels were broadly stable between March and April. While lower inflation, falling loan rates, and a rising real wage bill have supported two consecutive quarters of sequential private consumption growth, investment dynamics remain weak. After front-loading fiscal expenditure, an expected adjustment for the remainder of the year is expected. Capital goods imports continued to decline by double-digits in May (-13% yoy; -11.9% in April). According to the Financial Market Commission, outstanding loans in Chile from the banking system fell by 0.3% YoY in real terms in April, down from the +0.28% in March (-3.39% in April 2023), leading to the first annual contraction since January. Outstanding real commercial loans in Chile fell again, contracting by 2.67% in April (-1.31% in March, -5.76% in April 2023), declining on an annual basis since May 2022. Business sentiment is up from cycle lows but remains in pessimistic ground. While copper prices have retreated since the last meeting (from USD 4.9/lb to USD 4.4), they remain well above the 2013-19 average (USD 2.8/lb) and could spur a recovery in mining investment. We expect GDP growth of 2.8% this year (BCCh: 2.0% – 3.0%) and 2.0% in 2025 (BCCh: 1.5% - 2.5%).
Supply side pressures, including electricity price adjustments and passthrough from past CLP depreciation should keep inflationary pressures elevated. By May, tradable inflation continued to gradually tick up, while services CPI gradually edges down (in line with an output gap that is near closed). Tradables increased 0.4% MoM, corresponding to a 2.9% YoY increase in the reference series, up 0.3pp from April. Separately, energy prices rose by 0.4% MoM, still responding to the effects of prior CLP and global oil prices movements, leading to the annual print rising 1.1pp to 8.8%. We expect gasoline prices to start posting monthly falls from June. Non-tradables increased by 0.1% MoM, leading to a yearly rate of 4.2% (reference series; down 0.6pp from April), with services down 0.5pp to 4.2%. At the margin, we estimate that inflation accumulated in the quarter was 4.2% (SA, annualized), down from 5.2% in 1Q24 (but up from 3.2% in 4Q23). Meanwhile, core inflation reached 3.3% (SA, annualized, 4.5% in 1Q24 and 2.8% in 4Q23). Looking ahead, while the CLP is around 7% more appreciated than levels in 1Q25, CLP levels are still over 10% weaker over twelve months suggesting that passthrough pressure will persist ahead. Additionally, the implementation of the Electricity Tariff Stabilization Law should lift inflation during 2H24 and 1H25. Our current 4.1% and 3.1% CPI call for this year and 2025 considers accumulated electricity increases of around 20% this year (around 0.4pp contribution) and a further 20% next year (around 0.4pp contribution). However, there are significant upside risks.
Recent estimates by experts within the sector suggest the official readjustments are underestimated, with an accumulated increase during 2H24 potentially exceeding 40% (+1pp contribution).
A signaled price readjustment for transmission (10% weight) - not included in the original Law - would further increase inflation this year. Reports point to 60% average rise in Santiago (10% weight: +6% and 13bps).
The materialization of the upside electricity price risks would require us to raise our 2024 CPI call by 50-70bps (4.6-4.8%). Greater indexation pressures and second round effects pose upside risks to our 3.1% call for 2025 (by around 20-30bps). While the market starts to internalize such risks, medium-term inflation expectations remain anchored according to survey results and breakevens.
What not to expect… Considering the BCCh updated their structural parameters last December, we do not expect them to release new estimates just yet (probably December 2025). Separately, even though reserves (at roughly 14% of GDP) remain below the level targeted in the past (18%), we do not believe the BCCh will announce an accumulation process yet.
Our Take: A scenario of higher short-term inflationary pressures will add a layer of policy caution but not halt the cutting cycle. In May, the 50bp cut to 6% led to an ex-ante one-year real rate of 2.8%. With the 25bp cut this month to 5.75%, the ex-ante one-year rate would drop to 2.55% (still well above the 1% neutral level). The rate cut cycle would total 550bps. We envisage a relevant upward revision to the BCCh inflation forecasts resulting from electricity price adjustments. Nevertheless, the supply-side inflation shock is unlikely to de-anchor medium-term inflation expectations. Another key watchpoint will be the BCCh’s assessment of the persistence of copper prices on the investment outlook and the output gap. In any case, we expect the Board to drop the rate cut pace to 25bps and maintain a data dependent guidance. Developments on the global financial conditions will likely play a key role in determining the end point of the current cycle. The 1Q24 IPoM showed a corridor path (33% confidence interval) that averaged 5% in 4Q24 and 4% in 4Q25, we expect the path to neutral to be even slower. Our current scenario sees rates pausing at 5.25% this year before resuming a downward trend to 4.5% during 2025.
