Overall, the Chilean economy has evolved in line with forecasts in the September Report. Inflation has continued to recede amid the resolution of macroeconomic imbalances, including the closing of the activity gap, the normalization of aggregate demand and the easing of the cost shocks of the past few years. On the external front, the main economies have performed better than expected and global growth prospects have increased, with inflation declining in most countries. International financial conditions have improved in recent weeks, returning to the levels at the beginning of the year. In this context, estimates are that Chile’s GDP will close this year with zero growth, and that it will grow by 1.25%-2.25% in 2024 and 2%-3% in 2025. Headline inflation will continue to decline and will converge to 3% in the second half of 2024. The monetary policy interest rate (MPR) has accumulated a reduction of 300 basis points (bp) since July and stands at 8.25%. The Board considers that, in line with the central scenario of this Report, the convergence of inflation to the target will require further cuts in the MPR. Its magnitude and timing will take into account the evolution of the macroeconomic scenario and its implications for the trajectory of inflation.

Inflation has been declining further and is on track to reach the 3% target in the second half of 2024. As of November, the annual variations of headline and core CPI stood at 4.8% and 6.0%, respectively. The core part has led the decline in total inflation in recent months, especially in its goods component. In contrast, annual inflation of some volatile items has risen somewhat since the previous Report, including fuels and some foodstuffs. Volatile items also accounted for a large part of the high monthly CPI variation in November. At the same time, two-year inflation expectations are at 3% and the different measures show an earlier convergence to the target than in the September Report.

The decline in inflation from its 2022 peak has occurred in a context of a gradual resolution of macroeconomic imbalances. The moderation of spending, as well as the closing of the activity gap —which would have been completed during the third quarter— have allowed mitigating the inflationary pressures coming from our economy which for a long time grew above its capacity.

The process of inflationary convergence has also been sustained by the relief of the cost shocks of previous years. This takes into account the resolution of the pandemic-related logistical problems and the reversal of the significant increase in commodity and food prices caused by the war in Ukraine. Added to this is the impact of the appreciation of the real exchange rate (RER) from the peaks it reached in mid-2022, which has occurred in conjunction with a reduction in local uncertainty indices.

In this context, the local economy resumed slightly positive quarterly expansion rates, although there is still some heterogeneity among sectors. In seasonally adjusted terms, non-mining activity grew 0.2% in the third quarter (0.5% monthly according to the October Imacec). The resilience of the services sectors and the somewhat more favorable performance of wholesale and retail trade and electric power generation stand out, while construction remains weak.

On the demand side, third-quarter data show an incipient increase in private consumption. This occurs after a sharp contraction of this spending component between the end of 2022 and the beginning of this year, mainly in goods. The rebound of some durable goods stands out, while spending on services maintains positive growth rates.

The evolution of consumption has been accompanied by an improvement in real household incomes. The decline in inflation is supporting real wage growth and has eased its adverse impact on people’s financial spending. In the labor market, job creation remains sluggish, with demand for labor still weak, in line with the evolution of the economic cycle. The unemployment rate continues to stand above its historical average.

Gross fixed capital formation (GFCF) has been marked by the volatility that its machinery and equipment component has been dragging for several quarters. The latter contracted in the third quarter, which results in a further reduction in projected investment for this year. In any case, indicators such as wholesale sales of this goods category suggest that the decline has been reversing. On the other hand, investment in construction has continued to fall, coinciding with the pessimism in the perceptions of this sector.

About the external scenario, the main economies performed better in recent months, most notably the U.S. and China. In the U.S., the resilience of the labor market and consumption continues to provide support to the economy. In China, the boost came from the lagged effects of the post-pandemic reopening and the fall in savings, in addition to the reactivating measures implemented by the Chinese government. However, the problems of the Chinese real estate sector persist.

International financial conditions have behaved more favorably in recent weeks, returning to levels around those observed at the beginning of the year. Markets have been highly reactive to different types of events, including economic indicators that differ from expectations or communication from monetary authorities. This behavior peaked during part of October and November, when an episode of high volatility and global financial tightness occurred. Thus, during the fourth quarter the U.S. 10-year rate reached values close to 5%, the dollar appreciated and stock markets fell across the board. This reaction is due to different factors, including concerns about the fiscal policy in the U.S., uncertainty associated with a more complex geopolitical environment, and apprehensions about the medium-term saving-investment equilibrium. Add to this the evolution of monetary policy in the developed world.

The Chilean market has followed the movements of its external counterparts. In that period of October and November, the peso had an important depreciation and the long-term interest rate also followed international movements, showing a significant increase that was later undone. The October Monetary Policy Meeting was held in the midst of this volatile financial scenario. At it, the Board decided that it was necessary to continue with the cycle of MPR cuts, although this time around it was advisable to slow the pace down somewhat and reduce the rate by 50bp. Moreover, as a precautionary measure, they agreed to suspend the reserve replenishment program and the gradual reduction of its forward position.

The recent improvement in global financial conditions comes amid somewhat less restrictive communication from the Federal Reserve. Particularly at its last meeting, expectations arose of an additional cut in the U.S. policy rate during 2024. Rates have fallen globally, the dollar has depreciated and stock markets have risen. In Chile, the BCP10 rate is slightly above its level at the beginning of 2023. For its part, the peso has accumulated a depreciation of around 8% since mid-year, which is reduced to 1.5% when comparing the statistical cut-off of this Report and that of September.

Domestic short-term financial conditions for firms and households have been easing, supported by the MPR cuts. Mortgage rates, beyond a decrease in the margin, are at levels above those of a couple of months ago. Going forward, its trajectory is subject to several factors, among others, the movements of long-term rates and term premiums. Regarding credit performance, both its growth and demand remain weak in most portfolios.

Structural parameters

Trend non-mining GDP growth is assumed to slow over the next few years to average 1.9% in the period 2024-2033. This compares with the estimate of 2.2% for the 2023-2032 period in the December 2022 Report. This lower figure responds mainly to adjustments in the calculation resulting from the change in the reference decade covered by each average, and does not imply a substantive change in the projected path. Thus, the estimate again considers low growth in total factor productivity and that a good part of the recovery of labor participation to pre-pandemic levels has already occurred.

The nominal neutral MPR is estimated at 4% (+25bp with respect to the previous estimate). This is consistent with the increase in neutral monetary policy rates in other economies.

Projections

The central scenario assumes that headline inflation will converge to the 3% target in the second half of 2024, with the outlook remaining largely unchanged from September. This trajectory combines a core component that will approach 3% faster than expected, with a less favorable performance for the prices of fuels and other volatile items. In core inflation, the lower outlook for the core component of goods stands out, influenced by the greater decline accumulated in recent months. The central scenario assumes that the RER will remain around current levels across the projection horizon, in a context of high volatility of the nominal parity and a limited depreciation with respect to the previous statistical cut-off.

Activity and demand projections have few corrections. For 2023, zero GDP growth is anticipated. In addition to the upward revision of the figures for the first three quarters of 2023, the estimate considers a somewhat better outlook for year-end non-mining GDP, given the incipient improvement in sector data —such as in wholesale and retail trade and manufacturing.

For 2024 and 2025, the GDP growth ranges remain at 1.25%-2.25% and 2%-3%, respectively. In this projection, non-mining GDP will continue to show positive quarterly variations, gradually approaching rates in line with its trend growth. Mining activity will make an important contribution to the expansion of the economy in 2024, aided by the recent entry into operation of new mines and the development of other ores.

The activity gap is around zero and is estimated to remain close to that level throughout the projection horizon. Adjustments since the last Report are limited and include the revision of structural parameters and the improved outlook for non-mining GDP in the coming quarters.

Domestic demand is still expected to resume positive growth rates in 2024. Private consumption levels are marginally revised upward for the next two years. It is estimated to expand 2.1% in 2024 and 1.8% in 2025. The recovery of households’ disposable income will continue to support its performance, largely sustained by the inflation convergence process. The impact of the MPR cuts on credit conditions relevant to consumption is added.

In 2024 and 2025, GFCF will reach levels in line with those foreseen in the last Report, two years in which it will accumulate positive growth. This projection considers the improved outlook of investment surveys, particularly for the mining and energy sectors, and high frequency data.

Projections for the current-account deficit are 3.3% for this year and around 4% for the following two. As of the third quarter, it continued to decrease, accumulating 3.5% of GDP in the last moving year. This is coinciding with the gradual recovery of national savings —with a noteworthy increase in its private component—, whose improvement will continue to contribute to the equilibrium between national savings and investment.

The Chilean economy will be favored by greater growth expected for trading partners in the short term. It is estimated that this will average 3.1% between 2023 and 2024 (2.7% in September). On the one hand, there are better projections for the U.S., based mainly on the strength of consumption. On the other hand, there is the greater impulse provided by fiscal measures in China, which will anyway maintain expansion rates below historical averages. In addition, the copper price forecast for the next two years will remain at around US$3.8 per pound, which explains much of the upward revision to the terms of trade.

Monetary policy

The monetary policy interest rate (MPR) has accumulated a reduction of 300 basis points (bp) since July and stands at 8.25%. The Board considers that, in line with the central scenario of this Report, the convergence of inflation to the target will require further cuts in the MPR. Its magnitude and timing will take into account the evolution of the macroeconomic scenario and its implications for the trajectory of inflation. The Board reaffirms its commitment to act with flexibility in the event that any of the internal or external risks materialize and macroeconomic conditions so require.

In the sensitivity scenarios, the upper bound is defined by situations where inflation takes longer to complete its convergence to the target. Such would be the case if the Chilean economy were to receive a greater than expected external boost, for example because the resilience of the U.S. is prolonged and enhances the dynamism of the world economy. This would have positive effects on the local economy. On the one hand, due to greater external demand and improvements in the prices of different commodities, including copper, but would also affect the expectations channel, which could become more optimistic and encourage domestic spending. The inflationary consequences of this scenario could lead to more gradual cuts in the MPR than assumed in the central scenario.

The lower bound reflects scenarios in which inflation declines faster. These are especially associated with situations where the impact on the local economy of the recent months’ increase in long rates exceeds expectations. This could reduce the dynamism of consumption and investment, leading to a decrease in inflationary pressures that would require accelerating the monetary easing process.

Regarding risks, the evolution of the external scenario continues to be subject to important sources of uncertainty. The fragility of the Chinese real-estate sector, doubts about the fiscal situation of the U.S., and a more complex geopolitical environment with new armed conflicts are just some examples. The implications of these scenarios on monetary policy will depend on how the combination and magnitude of these elements ultimately affect the medium-term outlook for the convergence of inflation.

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