Broadly speaking, the macroeconomic scenario has evolved in line with forecasts in the June Report. Inflation has continued to fall, although it is still high, in a context where activity and demand have continued to advance in their adjustment process, cost pressures have been reduced and two-year inflation expectations stand at 3%. This has allowed the Board to reduce the Monetary Policy Rate (MPR) by 175 basis points (bp) since July, to 9.5% (figure 1). Although the decline in inflation is a global phenomenon, the outlook differs from one country to the next. Thus, while in some economies monetary policy is becoming less contractionary, in others a more prolonged tightening than anticipated is foreseen, particularly in the developed world. These divergences have been permeating global financial markets, with opposing movements in interest rates and depreciations in an important group of currencies, including the Chilean peso. The central scenario projections contain few changes with respect to our last Report. GDP will vary between -0.5 and 0% this year, to resume positive growth rates in the two subsequent years. Private consumption has stabilized and its projection is maintained, while investment is expected to contract somewhat less than expected this year. Headline inflation is expected to continue to decline, reaching 3% in the second half of 2024. Core inflation would do so in early 2025. If the central scenario projections of this Report materialize, in the short term the MPR will continue on the path outlined in the July Meeting. In any case, the magnitude and timing of the process of MPR reductions will take into account the evolution of the macroeconomic scenario and its implications for the inflation trajectory. Although the most extreme risk scenarios have been losing relevance, the process of inflationary convergence continues to pose significant challenges.

Inflation has continued to decline, but remains at high levels. In July, the annual variation of both headline and core CPI was 6.5% and 8.5%, respectively, below their peaks of 2022 (figure 2). In recent months, inflation has been falling somewhat faster than expected, which is due to the behavior of the core part of goods inflation. This is coupled with the decline in volatile components, especially energy. Services inflation has been slower to decline (figure 3).

Inflation has declined in a context in which the cost pressures seen in previous quarters have been receding. Beyond its recent increase, the nominal exchange rate is well below its levels in the middle of last year, which has been reflected in the evolution of goods inflation. Other cost factors have also contributed. Transport fares have decreased, global value chains have been reinstated, and external prices have come down after the rises they recorded at the outbreak of the war in Ukraine.

One key factor behind the decline in inflation has been that macroeconomic imbalances have shown progress in their resolution. This process has continued as anticipated in previous reports. Discounting seasonality, non-mining GDP declined 0.5% in the second quarter with respect to the first (figure 4). At the sector level, there was mixed performance. The dynamism of several service sectors contrasts with the poorer performance of wholesale and retail trade and construction, among others. This is in line with the outlook on the demand side, where goods consumption has declined the most, in contrast with the resilience of the services component. July’s Imacec showed a more positive performance of activity, although partly associated with temporary factors that favored personal services and electric power generation, among others.

The fall in private consumption has been moderating throughout the year. After a sharp contraction early this year, the second quarter saw a much more stable performance, in line with projections in the June Report (figure 5). Partial third-quarter indicators —such as retail sales and imports— confirm this trend. The durable goods component continues to accumulate the largest drop after its 2021 peak, although its level rebounded slightly in the second quarter.

Consumption behavior occurs at the same time as labor income has been stabilizing. Job creation remains constrained, with weak expectations about its future performance. Unemployment has oscillated between 8.5% and 8.8% for several months, amid the recovery shown by the labor force. Real wage growth has been increasing, influenced by the increase in the minimum wage and the impact of lower inflation.

At the margin, gross fixed capital formation (GFCF) showed an improvement in its tradable component, although its overall performance remains poor. In its seasonally adjusted series, investment in machinery and equipment grew 3.6% quarter-on-quarter, a result that came from several sectors, although with a higher incidence of mining and energy. At the same time, the construction and works component has been contracting since the end of 2022, in line with expectations (figure 6).

Regarding bank credit conditions, the MPR cuts have begun to be transmitted to market interest rates. Interest rates on commercial loans show declines, although their levels differ depending on size and/or risk rating (figure 7). Thus, the available data suggest that monetary policy transmission channels are operating as usual.

The external scenario continues to be marked by high uncertainty. On the one hand, financial risks continue to be present, amid expectations that monetary policy will remain contractionary in developed economies and the beginning of tightening cycles in several emerging economies. Inflation has continued to ease globally. However, the outlook varies across countries, which has influenced the actions of monetary policymakers. Thus, while the U.S. Federal Reserve has not ruled out the possibility of further rate hikes —the same as in Europe and the U.K.—, several central banks in emerging economies have already begun a process of cuts, Chile’s included. This keeps the risks associated with the permanence of high interest rates in the main economies latent. In addition, there are those linked to the delicate situation of regional banks and the implications of the credit rating downgrade in the U.S., among others.

Meanwhile, doubts about the performance of the Chinese economy have been intensified in recent months. Second-quarter activity data showed a somewhat stronger-than-expected slowdown, following the temporary boost from the lifting of Covid-related sanitary restrictions. Several short-term fundamentals appear weak. Among them, its complex real-estate situation, the deterioration of household and business confidence and the restructuring of world consumption towards services at the expense of goods. These elements interact with more structural vulnerabilities that have escalated in recent years, such as the high level of indebtedness of local governments and firms. All this in a scenario where the space for expansionary macroeconomic policies is narrower than in the past.

In this context, interest rates have reacted with rises in developed markets and mixed movements in emerging ones, a global appreciation of the dollar and, in recent weeks, a reduction in risk appetite. The Chilean peso has depreciated significantly from June to date. This is explained both by changes in the interest rate differential and by the greater risk aversion associated with incoming news, such as the situation in China, the fiscal outlook in the U.S. and the uncertainty about the global disinflation process. Other local financial variables have performed more favorably, such as the stock market and risk premiums, amid lower internal uncertainty.

Projections

The central scenario projections are largely unchanged from the June Report. Headline inflation will continue to decline and is expected to close the year at 4.3% annually (4.2% in June), and to converge to 3% in the second half of 2024 (figure 8). This projection takes into account the somewhat-lower-than-expected figures of recent months —particularly in June—, the impact of the recent peso depreciation, and higher external fuel prices. These last two elements help explain a slightly higher average inflation during 2024. The central scenario assumes that the real exchange rate (RER) will remain around its current levels over the projection horizon.

Core inflation will end 2023 at 6.3% annually (6.5% in June), reaching 3% in early 2025. The decline in the services component will be slow, due to the impact of indexation of wages and prices. In the goods component, beyond the effect of the peso depreciation, its decline will continue to be determined by more moderate demand pressures and the easing of external and internal cost factors.

In activity, revisions are few and focus on the mining sector. Expected growth for this year is between -0.5% and 0.0% (-0.5%/0.25% in June) (table 1). This projection takes into account the impact of the operating problems that have affected mining production in recent months, whose programmed increases throughout 2023 will become effective as of the fourth quarter of the year. Non-mining activity, meanwhile, will resume positive quarterly variations as of the end of this year, and will then gradually approach an expansion rate consistent with its potential level. Thus, for 2024 and 2025, total GDP expansion ranges of 1.25%-2.25% and 2.0%-3.0%, respectively, are expected.

This projection considers that the activity gap will continue to close in the remainder of the year, in line with the necessary conditions for the convergence of inflation. The evolution of the local economy has led to a narrowing of the activity gap, after several quarters of positive values. Towards 2024 and 2025, the gap is still projected to be negative, which will allow completing the inflationary convergence process within the policy horizon.

In the coming months, private consumption will remain near its current levels. For 2023, private consumption is expected to fall by 4.9% (same as in June), mostly due to the sharp decline of the first quarter. For 2024 and 2025, increases of 1.7% and 1.9% are projected, similar to previous projections.

For the medium term, the expected evolution of private consumption is consistent with a gradual recovery in real income and financial conditions becoming more favorable as the process of MPR cuts progresses. Real wages will continue to rise in the near future, in a context where the labor market will behave in line with the business cycle. In turn, the transmission of monetary easing to interest rates will gradually alleviate the financial burden on households.

Total GFCF will contract 1.2% this year and 0.6% next year. The weakness will be particularly visible in the construction and works component, as has been observed for the last few quarters. In any case, the difference in projections for 2023 compared to the estimate in June (-3%) stands out, mainly due to a better performance of machinery and equipment during the second quarter.

Towards 2025, GFCF is projected to resume positive growth rates. That year, growth of 2.4% is anticipated for this part of spending (2.2% in June). This will occur amid easing domestic financial conditions, which will support the positive impact of the reduction in local uncertainty that has been observed since the end of last year. The Capital Goods Corporation’s Survey reported an increase in projected investment amounts for 2024 and 2025, especially in mining, although they are still lower than in the previous two years.

The current account deficit will decline further this year, in line with the gradual recovery of private savings. Cumulatively over twelve months, this deficit fell to 4.5% of GDP in the second quarter (6.6% in the first quarter). The successive restoration of the savings-investment balance will cause the current account deficit to reach 3.4% of GDP in 2023 and to stand at 4% in the next two years.

The Chilean economy will continue to receive a modest impulse from abroad. As in the June Report, trading partners’ growth is forecast to average 2.8% between 2023 and 2025. This takes into account a different composition in performance among countries. On the one hand, because of a downgrade in the outlook for China this year and, on the other hand, because the U.S. is expected to have a more moderate and delayed recession. The terms of trade do not show significant changes either.

Monetary policy

The macroeconomic scenario has evolved as anticipated, with inflation projected to converge to the 3% target in the second half of 2024. If the central scenario projections of this Report materialize, in the short term the MPR will continue on the path outlined in the July Meeting. This means that, at the end of the year, the MPR would be between 7.75 and 8%. In any case, the magnitude and timing of the process of MPR reductions will take into account the evolution of the macroeconomic scenario and its implications for the inflation trajectory and the achievement of the 3% target within the policy horizon.

With respect to the sensitivity scenarios, the upper bound of the corridor reflects scenarios in which the inflationary convergence process is less favorable than expected. For example, this could occur in a situation where the world economy shows greater resilience, particularly in the U.S., and further increases in commodity prices are observed. This would generate greater inflationary pressures globally, which would be transmitted to local inflation. Its medium-term inflationary effects could be more persistent if there is a correction of inflation expectations.

The lower bound of the corridor reflects scenarios in which the inflationary convergence is faster than anticipated. This could be the case if the economy faces lower-than-expected pressures from the demand side. Such a situation would arise if activity is subject to shocks that reduce the external impulse; if there is a deterioration in business and household confidence that impairs the performance of investment and consumption; or if the impact of credit conditions is greater than initially estimated.

About the risks faced, they are still mostly associated with the global macro-financial situation. The same as in June, the possibility that a further deterioration of the economy could trigger episodes of high volatility, reduced liquidity and incentives for capital outflows from the emerging world continues to stand out. In addition to the sources of risk previously identified, there are also doubts about China, especially regarding the evolution of its economy and financial market. The implications of these scenarios for monetary policy will depend on how the combination and magnitude of these elements affect the outlook for medium-term inflation convergence.