The economy has been advancing in the resolution of the macroeconomic imbalances accumulated in recent years. This has helped to reduce inflation in line with expectations, making progress in consolidating its convergence to the 3% target. In general, domestic activity and demand have evolved as expected, although with a steeper-than-expected decline in the durable component of private consumption. The central scenario projections show limited changes in magnitude. For this year, activity is expected to grow between -0.5% and 0.25%. In 2024 it will grow between 1.25 and 2.25% and between 2% and 3% in 2025. World activity began the year with greater dynamism and financial volatility has been reduced. Nevertheless, a scenario of tight financial conditions continues to be projected, in an environment where uncertainty remains high and a more contractionary monetary policy is expected in the main economies in the face of the challenge of curbing their inflation rates. The monetary policy rate (MPR) has been kept contractionary for several quarters, which has contributed significantly to bring down inflation. While inflationary risks persist, they have been balancing out. The Board believes that the most recent evolution of the economy points in the required direction. If these trends continue, the MPR will start a downward process in the short term. The magnitude and timing of its reduction will consider the evolution of the macroeconomic scenario and its implications for the inflation trajectory. The Board reaffirms its commitment to act with flexibility in case any of the identified internal or external risks comes true and macroeconomic conditions so advise

Headline and core inflation have declined as expected, the latter by less and more slowly. The annual variation of these indicators stood at 8.7% and 9.9% respectively in May. The decline in inflation has been driven by the volatile component and the goods component, while the core services component remains high. At the same time, the different measures of inflation expectations have receded and in the two-year horizon have been aligning themselves with the 3% target.

The context for the decline in headline inflation is one in which the economy has been making progress in reducing the macroeconomic imbalances accumulated in previous years. Incoming data suggest that the activity gap has resumed its closing process in recent months, as anticipated in March. A more comprehensive look at capacity gaps shows that they have been closing for some time now.

In addition, cost pressures have been easing, although they remain high by historical standards. Of note are the reestablished supply chains, the normalization of global transportation costs, the decrease in external prices and the appreciation of the peso from the end of 2022. Meanwhile, headline and core inflation levels are still high, and their effects are still present in various areas of the economy. In this context, more contained cost pressures are observed in companies, as reported by the Survey of Price Determinants and Expectations (EDEP), and a trajectory towards normal values in the frequency of upward adjustments in the prices of goods.

In the past few months, activity and demand have evolved according to forecasts in the March Report. On the expenditure side, the main developments are concentrated in consumption. In seasonally adjusted terms, private consumption fell 2.5% quarter on quarter (q/q), more than expected and mainly explained by the 18.8% q/q decline in durable consumption. Government consumption, on the other hand, grew more than projected. In any case, the adjustment in private consumption is interpreted as an anticipation of the decline expected for this year, in line with high-frequency data, such as imports. On the supply side, the worsened performance of the mining industry stood out.

On aggregate, the performance of private consumption has been adjusting along with less dynamism in the labor market and tighter financial conditions for individuals. The composition of job creation has shifted from formal wage earners to self-employed and informal salaried occupations. Taken together, this has maintained a low job creation rate for several months. In turn, the unemployment rate rose to 8.7% in the February-April quarter and real wages remain sluggish, still affected by high inflation. Conditions for accessing credit have tightened for households (Bank Lending Survey, first quarter), while their financial burden has increased (Financial Stability Report, first half 2023).

Investment remains weak, in line with the evolution of the macroeconomic scenario. Adjusting for seasonality, gross fixed capital formation (GFCF) has remained stagnant for several quarters in its different components. Indicators such as imports of capital goods, housing sales and construction activity (Imacon), all confirm this low performance outlook.

The cumulative 12-month current-account deficit narrowed from 9% of GDP in the latter part of 2022 to 6.9% of GDP in the first quarter of this year. This fall was somewhat deeper than expected. The current-account balance improved significantly early in the year, in line with the ongoing adjustment of the economy. This affected via a decrease in imports of consumer goods, consistent with a rebound in household savings. The higher value of exports in some goods categories also contributed to this result.

On the external front, even though in the first quarter China expanded more than expected and labor markets in developed countries remained dynamic, global growth prospects remain poor. The inflationary problem persists, mainly due to the high levels of core inflation in much of the world. In developed economies, although several central banks are close to ending their rate hike cycles, market expectations suggest a more prolonged monetary contraction than anticipated in March. This is particularly noticeable in the U.S., where the dynamism of the labor market and consumption has been surprisingly strong. In the Eurozone, the most recent data points to weakness in the bloc’s economy, but monetary authorities continue to signal future hikes. Going forward, tight external financial conditions —linked to inflation control— and low fiscal policy space are expected to have a negative impact on the global economy. In this sense, credit dynamics in developed countries anticipate a weak performance of activity and investment.

Global financial conditions remain tight, even as volatility associated with the recent bank-related tensions has diminished. With respect to the March Report, long-term interest rates have shown mixed movements, with increases in developed countries contrasting with decreases in emerging ones. Currencies have also performed unevenly, while stock markets, in general, have traded upwards. In any case, the evolution of the U.S. banking system continues to be a source of uncertainty. Market sentiment remains fragile, with doubts about the extent and magnitude of vulnerabilities in the financial system.

In Chile, the financial market has become aligned with a scenario where inflation will converge to the 3% target and the MPR will reduce its level of restrictiveness. All this has occurred in a context where the economy has further adjusted and local uncertainty has diminished. It is worth highlighting the local exchange market, whose proper functioning has allowed the Central Bank to dismantle the position of the NDF program and activate a program to hoard international reserves, aimed at strengthening the country’s international liquidity position.

Projections

The central scenario projections contain minor changes with respect to the March Report. Inflation is expected to drop further, converging to the target in the second half of 2024. For December of this year, the annual variation of total and core CPI is projected to be somewhat less: 4.2% (4.6% in March) and 6.5% (6.9% in March), respectively. Both indicators will converge to 3% during 2024 and will remain there until the end of the policy horizon, i.e., the second quarter of 2025.

Core inflation will decline more noticeably towards the end of 2023 and the turn of 2024, matching forecasts in the March Report. The projections reiterate that, in the short term, services inflation will maintain monthly variations above historical averages. This incorporates the greater rigidities that these prices normally present and the impact of the still high inflation on the usual indexation mechanisms. Goods inflation, meanwhile, will benefit from a real exchange rate (RER) that will be lower than estimated in March. This is consistent with the nominal appreciation of the peso in recent months, in a context of reduced local uncertainty. Going forward, the effects of tight external financial conditions continue to be considered.

Compared to March, activity projections show minor changes, mainly associated with the performance of the mining industry. This year, the annual variation of GDP will be between -0.5% and 0.25% (-0.5 to +0.5% in March). The economy is expected to grow between 1.25% and 2.25% next year (1% to 2% in March) and between 2% and 3% in 2025 (same range in March). In this scenario, the activity gap will turn negative during the second half of 2023 and will remain at these values for several quarters.

Projections continue to assume an adjustment in spending concentrated in its imported component, especially in consumption. During this year, private consumption is expected to further decline, with a variation of -4.9% in 2023 (-3.8% in March). Going forward, the speed of adjustment of this spending component is projected to be slower than in the first quarter. The projected path for consumption considers that the labor market will perform in line with the business cycle, including worsening hiring prospects and a gradual rebound in labor participation. It also factors in consumer pessimism, tighter lending conditions and a heavier financial burden.

The drop in consumption is consistent with a recovery of household savings, after their massive use in previous years, which is a key factor in the reduction of the current-account deficit. Private savings already posted a recovery in the first quarter this year. From now on, its level will be above those of the years immediately preceding. Public savings will remain around 2% of GDP over the projection horizon, consistent with compliance with the structural balance target. The current-account deficit is expected to close this year at 3.7% of GDP, to stand at around 4% in 2024 and 2025.

In the central scenario, GFCF will maintain a low performance. This projection continues to consider the complex external scenario, with high uncertainty and still stringent financial conditions. Survey information also points to low investment levels for the coming quarters, while entrepreneurs’ expectations remain pessimistic, particularly in the construction sector.

The external impulse relevant to Chile will remain moderate. However, the higher-than-expected expansion in the first quarter, particularly of China, leads to higher trading partners’ growth for 2023, going from 2.4% in March to 3.0% in June. For 2024 and 2025, there is no change, with projected increases of 2.3% and 3.0%, respectively. The outlook for commodity prices is also largely unchanged. A downward trajectory is again anticipated, in line with the weakening of the international scenario.

Monetary policy

The MPR has been kept contractionary for several quarters, which has contributed significantly to bring down inflation. While inflationary risks persist, they have been balancing out. The Board believes that the most recent evolution of the economy points in the required direction. If these trends continue, the MPR will start a downward process in the short term. The magnitude and timing of its reduction will consider the evolution of the macroeconomic scenario and its implications for the inflation trajectory.

The borders of the MPR corridor reflect sensitivity scenarios where the speed of inflationary convergence leads to rate adjustments different from those in the central scenario. On this occasion, the Board believes that such scenarios are mainly associated with domestic conditions. In particular, because of the dynamics of inflation and its fundamentals.

The upper bound is defined by events in which local inflation is more persistent than expected. In this aspect, the information provided by the actual expenditure and CPI records will be key. The Board will evaluate the inflationary implications of these events, as they could mean slowing down the process of reducing the MPR. At the same time, upward inflation surprises in developed economies could call for higher international monetary policy rates, which would contribute to a depreciation of emerging currencies, including the peso. This would push up local inflation in the short term, although its impact on the MPR would be mitigated as it would imply a greater contraction in activity and spending.

The lower bound of the MPR corridor reflects a scenario where the adjustment of the Chilean economy is faster than expected, leading to an earlier convergence of inflation. Various indicators of capacity gaps suggest that inflationary pressures have been gradually contained. A scenario where such gaps become more negative than expected would lead to a more accelerated reduction of the MPR. Such could be the case if the labor market and private consumption would show a more marked deterioration.

As for risks, they are significant and emanate mainly from the global macro-financial situation. A further deterioration could trigger episodes of high volatility, reduce liquidity and encourage capital outflows away from the emerging world. This would lead to a greater than expected tightening of global financial conditions, which would cause additional restrictions for the Chilean economy, significantly reducing inflationary pressures. In such a risk scenario, more pronounced cuts in the MPR than indicated by the lower bound of the corridor would be needed.