Chile's Strategic Rate Hold: A Pivot Point at the Growth-Inflation Convergence

The central bank has reached a clear inflection point. After a unanimous 25-basis-point cut in December to 4.5%, it is now poised to hold steady. The rationale is a convergence of two powerful forces: inflation is finally lining up with the target, and growth is accelerating. This setup marks a definitive shift from an easing cycle to a period of policy patience, as officials wait for clearer signals on the sustainability of this new equilibrium.

The inflation story is one of faster-than-expected progress. Both headline and core inflation stood at 3.4% year-on-year in November, a significant drop from earlier levels. The central bank's own projections now see this convergence reaching the 3% target in the first quarter of 2026. This acceleration, driven by a stronger peso and favorable cost factors, has diminished near-term risks and removed a primary justification for further cuts.

At the same time, the growth outlook has been upgraded. The December policy meeting saw the bank raise its 2026 growth forecast, now seeing GDP expanding as much as 3% this year. This uptick is fueled by a pick-up in investment, particularly in machinery and equipment, alongside a supportive external environment boosted by elevated copper prices. The improved economic dynamism strengthens the case for holding rates, even as inflation slows.

The bank is navigating a delicate balance. While the dominant option at the December meeting was a cut, one member did flag the possibility of a deeper reduction, citing a closed output gap. That alternative was quickly dismissed, underscoring the board's caution. As the minutes noted, the board is wary of signaling that the inflation problem was resolved. The current 4.5% rate sits within the bank's estimated neutral range of 3.75% to 4.75%, a zone that neither stimulates nor restricts activity. For now, that neutrality is the intended stance, as the bank awaits confirmation that the recent inflation-growth convergence is durable.

Structural Drivers: The Growth-Inflation Nexus

The central bank's patience is being tested by a growth story that is both promising and fragile. The latest GDP data reveals a sharp contraction of 0.1% in the third quarter of 2025, a stark reminder of the economy's vulnerability. This weakness was not a broad-based slump but a sector-specific drag, with the mining industry performing poorly and pulling down overall activity. Yet, beneath this headline figure, a more dynamic engine is emerging.

The new growth engine is domestic demand, particularly investment. The central bank noted that investment in machinery and equipment grew again more than projected, a key indicator of business confidence and capacity expansion. This is complemented by a strengthening labor market, where the unemployment rate has declined in recent months. Together, these forces point to a pickup in internal momentum, which the bank has factored into its upgraded 2026 growth forecast.

Externally, support is robust. The price of Chile's primary export, copper, has been a powerful tailwind, rising significantly to more than US$5 per pound. This surge improves the country's terms of trade and provides a direct boost to export revenues and government finances. Furthermore, the global economic backdrop is more resilient than feared, with activity in main trading partners outperforming expectations. This external strength has also contributed to a strengthening of the Chilean peso, which helps anchor inflation.

Assessing the durability of this growth outlook requires weighing these competing forces. The weak mining sector remains a structural vulnerability, capable of derailing quarterly prints. However, the resilience in non-mining GDP, the dynamic investment cycle, and the supportive external environment create a foundation for a more balanced expansion. The central bank's cautious stance reflects this tension: it sees enough momentum to justify holding rates, but not enough to rule out the need for future adjustments if the growth-inflation convergence proves fleeting.

Financial Market and Balance Sheet Implications

The central bank's decision to hold rates at 4.5% is now being reflected in financial conditions, which have broadly mirrored a favorable global backdrop. Domestic markets have followed international trends, with stock prices rising and long-term interest rates declining in recent months. The Chilean peso has also appreciated, holding near multi-month highs. This environment of improving financial conditions and a stronger currency provides a supportive cushion for the economy, aligning with the bank's goal of a smooth inflation convergence.

Yet, the board's caution is evident in its revised assessment of the policy landscape. In the December report, the central bank slightly raised its nominal neutral rate range estimate to 3.75%-4.75%, a 25-basis-point increase from the prior estimate. This upward revision signals that the bank now views the rate of interest that neither stimulates nor restrains growth as higher than previously thought. It underscores a key point: the policy stance is not yet in a position of excess accommodation. The current 4.5% rate remains within this newly elevated neutral band, but the bank is not signaling that it is close to a permanently lower equilibrium.

This measured outlook was reinforced by the board's internal deliberations. While the dominant option was a 25-basis-point cut, one member did raise the possibility of a deeper reduction. That alternative was quickly dismissed, with other members emphasizing the need to avoid signaling that the inflation problem was resolved. This decisive rejection of a more aggressive move is a clear signal that the board is not yet confident that inflation risks have fully dissipated. It highlights the delicate balance they are maintaining-holding steady to allow the convergence to solidify, but not cutting further until they see more durable evidence that the inflation target is secure.

The bottom line is that the central bank is in a position of strategic patience, supported by a more resilient financial environment. The market's positive reaction to the hold decision reflects this stability. However, the board's internal caution and its upward revision of the neutral rate range indicate that the door for future cuts remains open, but only after a period of observation. For now, the policy stance is set to wait and see, letting the economy's growth-inflation convergence play out before making its next move.

Catalysts and Scenarios: What to Watch

The central bank's strategic patience now hinges on a clear set of forward-looking catalysts. The primary test is the sustainability of the growth-inflation convergence it has just begun to observe. The board's own projection that inflation will reach its 3% target in the first quarter of 2026 is the benchmark. Any deviation from this path, particularly a resurgence in price pressures, will be scrutinized closely. The board has shown it is not yet ready to signal that inflation risks have fully dissipated, as evidenced by its rejection of a deeper rate cut in December. For now, the hold decision is a wait-and-see posture, but the next move will be dictated by the data.

The near-term data releases are critical. The first major test will be the Q4 2025 GDP report, which will show whether the recent uptick in investment and domestic demand is broadening into a sustained expansion or remains fragile. This will be followed by the inflation reports for February and March, which will provide the first hard evidence on whether the projected convergence is materializing on schedule. The board will be watching for signs that the recent decline in inflation is durable, not just a temporary dip.

The timing of the next policy meeting is also a key event. The bank's decision to hold steady at 4.5% will be formally confirmed at its meeting on January 27, 2026. This gathering will not only ratify the hold but also provide forward guidance. The board's language here will be telling. Given its internal caution, as seen in December's minutes, the guidance is likely to emphasize the need for more evidence before any future cuts. The board is wary of prematurely signaling that the inflation problem is resolved, a risk it actively avoided last month.

In practice, the catalysts are twofold. First, the board needs to see the inflation target hit and stay there, confirming that the recent progress is structural. Second, it needs to see growth momentum solidify, reducing the vulnerability exposed by the 0.1% Q3 contraction. If both conditions align, a gradual easing cycle could resume. If either falters, the bank may extend its period of patience. The setup is one of deliberate observation, where the next policy move will be a direct function of how these key data points unfold.