Chile Cuts Rates, Warns of Inflation Risks

The Central Bank of Chile (BCC) has reduced its monetary policy interest rate by 25 basis points to 5.5%, signaling a cautious approach to economic recovery while acknowledging potential inflation risks. The decision, announced on September 14, 2024, reflects the BCC's commitment to maintaining price stability and supporting the country's economic growth.

The BCC's move comes amidst a backdrop of increased global market volatility and a slowdown in domestic economic activity. In the second quarter of 2024, Chile's GDP contracted by 0.6% quarter-on-quarter, while unemployment rose to 8.7%. Inflation in July exceeded expectations, reaching 4.4% driven by volatile components, although core inflation aligned with the 3% target over two years.



The BCC's decision to cut rates was unanimous, with policymakers noting the need for caution due to upward risks to inflation. The board signaled that if the central scenario holds, the pace of rate cuts may accelerate, reaffirming its commitment to achieving a 3% inflation target within the next two years.

The BCC's commitment to a 3% inflation target is crucial for guiding economic agents' expectations and providing a clear reference for price evolution. This target helps manage inflation expectations, which are a key driver of actual inflation. By maintaining a consistent and transparent communication about its commitment to this target, the BCC fosters confidence in its ability to control inflation, thereby influencing economic decisions and promoting stability.

The BCC's recent rate cut aligns with its inflation-targeting scheme, which guides its monetary policy decisions. This scheme helps stabilize prices and manage economic uncertainty. The main operational instrument of monetary policy, the monetary policy interest rate (MPR), is adjusted to achieve this target.

Domestic economic activity, unemployment, and wage growth significantly influence inflation in Chile. As economic activity resumes, it boosts demand, potentially driving up prices. Unemployment, currently at 8.7%, impacts inflation through labor market dynamics. Lower unemployment can lead to increased wage demands, pushing up production costs and, consequently, prices. Wage growth, though stable at 3.5% in May, could accelerate if unemployment falls, further fueling inflation.

The evolution of core inflation and inflation expectations will influence the BCC's monetary policy decisions. Core inflation, which excludes volatile items, has aligned with the target, while headline inflation exceeded expectations at 4.4% in July. Inflation expectations remain at 3% two years ahead, reflecting confidence in the BCC's work. As the economy recovers and domestic demand boosts inflation, the Board will monitor risks and adjust the monetary policy rate accordingly, ensuring convergence to the 3% target.

In conclusion, the BCC's decision to cut rates while acknowledging inflation risks demonstrates a balanced approach to monetary policy. By maintaining its commitment to a 3% inflation target, the BCC fosters confidence in its ability to control inflation and promote economic stability. As the Chilean economy recovers, investors should closely monitor inflation dynamics and the BCC's policy responses to make informed investment decisions.