The 2Q24 monetary policy report (IPoM) shows an output gap remaining positive for longer, along with a significantly higher inflation path, leading to the nominal policy rate trajectory being raised by 50bps, on average, over the policy horizon. With the decision to cut rates by 25bps to 5.75%, the Board signals that the bulk of the planned cuts for this year have materialized. The macroeconomic situation and subsequent effects on the inflation outlook will determine future movements. The external impulse is revised marginally up over the forecast horizon. Domestically, the moderate upward revision to growth this year responds to a better start to the year, while higher copper prices boost investment dynamics ahead. A higher projected inflation path incorporates the impact of the supply-shock associated with upcoming electricity price adjustments along with improved domestic demand. A more appreciated path for the real exchange rate helps offset part of the upside inflationary pressures. Overall, the 2Q IPoM update comes broadly in line with expectations, confirming the need to adopt a more cautious approach as rates gradually edge closer to the ceiling of the nominal neutral range (3.5–4.5%). Developments in the US will always play an important role in determining the space EMs have to lower rates. The IPoM foresees no changes in the Federal Funds Rate this year. We expect the BCCh to cut rates to 5.25% in two 25-bps adjustments, followed by a prolonged pause. We cannot rule out pauses in-between adjustments.
Higher projected copper prices are a key development. The IPoM notes the copper price increase responds to transitory and other persistent factors. The price path was revised up to USD 4.3 per pound between 2024 and 2026 (versus USD 3.85 in March). The revision is expected to boost investment, private sentiment, and the current account balance. The overall activity scenario sees a growth range of 2.25 -3.0% for this year, raising the floor of the range by 25bps versus the March scenario. Over the medium term, the positive boost of higher copper prices on the domestic economy are negated by the drag from higher inflation on disposable household income. As a result, the growth range of 1.5 to 2.5% were retained for 2025 and 2026. The copper price adjustment raises the prospects for mining investment, mainly over the medium-term, resulting in favorable spillovers to the economy. Gross fixed investment is still expected to contract this year (yet more mildly). In the medium term, improving financial conditions and upgrades to the 5-year investment pipeline (10% greater investment for the 2024-2027 period) consolidate an improved investment trajectory. The consumption outlook is also upgraded in the short-term. The evolution of the labor market will continue to support the performance of the wage bill. Over the medium- to long-term, the contractionary effects of the electricity price increases will hinder private consumption dynamics. Public consumption is expected to moderate to comply with the fiscal rule. Overall, the positive output is now seen remaining positive until the final quarter of 2025, compared to 4Q24 in the March IPoM.
Raising the inflation path. This IPoM incorporates an estimate of the upcoming electricity price adjustment following the approval of legislation in April. Based on legislation and the energy regulator’s preliminary report, the BCCh incorporated an accumulated effect of 145bps over the next year (122bp being direct). Overall, total inflation estimates rose significantly, particularly during 2025. A far milder effect is seen for core prices (related to cost adjustments in companies with regulated tariffs and price and wage indexation processes). Part of these effects is compensated by a stronger real exchange rate path compared to March (placing downward pressures on goods inflation). Overall, annual inflation is now seen ending the year at 4.2% (3.8% in March). For 2025, inflation would close at 3.6% (3.0% in March), with average inflation being 1.1pp higher during that year. Headline inflation is projected to converge to 3% in the first half of 2026.
A more cautious policy rate path ahead. In the BCCH’s baseline scenario, most of the rate cutting cycle has already unfolded. In nominal terms, the signaled rate path is somewhat above the March forecast. Meanwhile in real terms, the path is less restrictive in the short-term (due to higher inflation expectations), while similar in the medium-term. The less restrictive MP in the short-term supports our view that the Board has room to be more cautious and pause at a higher nominal rate than previously signaled. The 33% confidence interval now shows an average rate of 5.5% in 4Q24 (5% previously) and 4.6% in 4Q25 (4% previously). Yet, the ex-ante one-year rate outlined for 4Q24 is now 1.4% (versus 2.5% in March), near the upper bound of the real neutral range (0.5 -1.5%). However, monetary policy could follow a different path than the central scenario. The upper bound of the corridor is consistent with more persistent inflation (6% rate average in 4Q24). The lower bound considers far milder inflationary pressures (4.7% average in 4Q24). The central bank notes the current scenario grants greater flexibility to monetary policy than in previous quarters, particularly due to the resolution of macroeconomic imbalances, along with the fall of inflation and inflation expectations.
Our Take: The scenario of higher inflationary pressures and improved domestic activity means the rates cycle is close to a prolonged pause. The upside revision to the inflation trajectory means monetary policy is less restrictive than previously expected, permitting room to pause the cutting cycle soon. The estimated impact of electricity price adjustments on inflation is not dissimilar to what we had outlined, albeit with differences in the timing. We believe that in the context of higher projected inflation, the Board will tread carefully, ensuring that inflation expectations at the two-year horizon remain anchored. Having taken the ex-ante real rate closer to neutral, the Board has added flexibility in terms of future decisions. Our current scenario sees rates pausing at 5.25% this year before resuming a downward trend to 4.5% during 2025. We do not rule out pauses before reaching 5.25%. The BCCh will publish the minutes of the June meeting on July 4. The next monetary policy meeting will be on July 31.
