Inflation and its short-term outlook have continued on an upward path, and levels near 10% are anticipated by mid-2022. The higher inflation is having a significant impact on households, and continues to respond mainly to the overspending of recent quarters. This impact has been heightened against a backdrop of significant cost-push pressures, which have increased again due to the commodity price shock triggered by Russia’s invasion of Ukraine. The central projection scenario considers that in the latter part of 2022 inflation will begin to converge to the 3% target, which will be reached within the two-year horizon. Resolving the imbalances that accumulated in the economy in recent quarters is vital for this convergence, fundamentally by adjusting the fiscal and monetary impulse, among other measures. Consistent with this, and with a less favorable external scenario, after the excessive growth of 2021, the economy will grow under its potential in 2022 and 2023, with contractions in private consumption and investment. The Board has rapidly adjusted the MPR to a contractionary level, which is necessary for it to contribute to the closing of the activity gap and the convergence of inflation within the monetary policy horizon. Also, considers that, if the assumptions in the central scenario prove correct, future increases in the MPR would be smaller than those of recent quarters.

Inflation has continued to rise, approaching 8% annually. Most CPI components showed upward annual variations, particularly the rapid increase in the core CPI for goods, which went from around 5% in mid-2021 to around 9% early this year. Services showed a lower annual variation, close to 5%, explained by the freezing of several regulated tariffs in recent years and lags in the indexed prices adjustments (figure 1).

Grafico 1: inflación

The strong boost to spending during 2021 continues to be the main driver of higher inflation. Its impact has been accentuated in a scenario of significant and escalating cost pressures. Global supply chains have yet to recover from the effects of the pandemic and, among other factors, continue to experience disruptions due to the rise in Covid-19 infections and China’s zero tolerance policy. The prices of several commodities (i.e., energy, foods, and some metals) have reached high levels, a situation that is exacerbated by the peso’s depreciation over the last couple of years (figure 2). On top of this, labor costs have risen and supply has not yet fully recovered from the impact of the pandemic. Different sources of qualitative information —IMCE and Business Perceptions Report (IPN)— show companies’ negative assessment of the behavior of their costs and their impact on margins.

Gráfico 2: costos

The increase in domestic inflation has gone beyond the December forecast, and most of the surprise has been concentrated in the core component of the CPI. Cumulative annual inflation to February 2022 was close to 1 percentage point higher than anticipated in December’s central scenario. More than half of this surprise came from higher increases in the prices of the goods in the core CPI basket. A lesser part of the surprise came from food and fuel prices included in its volatile component (figure 3).

Gráfico 3: sorpresas inflacion

Inflation’s short-term outlook has increased, approaching 10% in the middle of the year. Several factors are combined in this projection. In a context where domestic demand is still exceptionally high, the main factors are high and increasing cost-side pressures, which cause further price increases. This also suggests that part of the recent inflation surprises will be more persistent, as they reflect margins adjusting to the deterioration they experienced in recent quarters. There are also the recent hikes in the prices of certain commodities due to Russia’s invasion of Ukraine and a real exchange rate (RER) is currently high. Coupled with this is the indexation to higher past inflation, which would have a particular impact on the monthly CPI variations during March and April, so both figures are expected to be high.

The current high inflation affects economies across the world, although their underlying causes are not necessarily the same. In the United States and the United Kingdom, the main drivers have been strong demand and the tight labor market, with contained supply and upward pressure from wages. In the Eurozone, energy has been the main cause of inflation, contributing around half of the increase. In several Latin American economies, the main culprit is associated with higher energy and food prices.

In the central scenario, annual CPI inflation will see a fast decline starting in the second half of 2022, to hover around 3% in early 2024. This decline in inflation will be intensified by falling prices of energy and some foods. Core inflation, on the other hand, will decline more slowly, more influenced by the reversal of the activity gap. Still, it should also stand around 3% by the turn of 2024 (figure 4).

Gráfico 4: Proyección inflación

A fundamental factor for the convergence of inflation to the target is that the imbalances that the economy accumulated during 2021 are resolved. In the central scenario, in 2022 and 2023 the economy will grow below its potential, a necessary condition to narrow the gap caused by the excessive increase in spending observed last year. This will be compounded by a reduction in fuel prices from their current levels and an RER that will be lower, but still above its averages of the last 15 to 20 years.

Data for late 2021 and early 2022 suggest that the economy is already on a downward path from last year’s record high spending, a process that is occurring somewhat faster than anticipated. The level of private consumption, particularly of durables, declined during the last quarter of 2021, as did wholesale and retail trade activity. The latter extended into early 2022. First-quarter leading indicators, such as digital sales and imports, also show a decline from last year’s highs (figure 5 and 6).

Gráfico 5 Imacec por sectores

Gráfico 6: Demanda interna

In the central scenario, private consumption and gross fixed capital formation (GFCF) will contract in the two-year period 2022-2023. For consumption, the high basis for comparison will be key, as will be the reduction of liquidity accumulated over the last few quarters—part of which has been saved— and the drop in credit availability (figure 7). In the GFCF contraction, the tightened financial conditions and the persistence of high uncertainty will play a very important role (figure 8 and 9).

Gráfico 7: Saldos personas

Gráfico 8

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Gráfico 9: Catastro

The annual GDP variation will be negative for several quarters, and estimates are that activity will grow between 1.0% and 2.0% in 2022, and between -0.25% and +0.75% in 2023. It is worth noting that these estimates are significantly different from private expectations (i.e., the median of the Economic Expectations Survey and Consensus Forecast, both from March 2022), which assume that both consumption and investment will continue to expand in 2022 and 2023, and that GDP will rise above the upper bound of the range foreseen for each year. Towards 2024, once macroeconomic imbalances are resolved, expectations are that activity will resume growth rates in line with its potential, that is, between 2.25% and 3.25%.

The scenario of inflation convergence and resolution of macroeconomic imbalances is based on a significant reduction in fiscal spending during 2022. Pending the new administration’s decree on fiscal responsibility, the central scenario maintains its assumption that public spending will be that of the approved budget and the convergence path outlined therein, in accordance with indications from the Ministry of Finance.

The central scenario projection considers that, despite the higher copper price, the external impulse that Chile will receive will be lower than expected in December. The rise in inflation and the central banks’ responses will lead to less comfortable financial conditions, which is already reflected in the behavior of the prices of different assets. In turn, projected world growth for this year is reduced to 3.1% (4.2% in December) and remains at 3.4% for 2023.

The war in Ukraine has introduced an additional adverse factor into the macroeconomic scenario, although so far its direct impact remains limited. The conflict has a significant effect on import prices, especially due to the sharp rise in the oil value with respect to the previous Report’s projections (around 30% for the 2022-2023 average). In terms of world growth, the progression of the war and the sanctions imposed on Russia will have major effects on the performance of the Eurozone, which will translate into a lower growth forecast for Chile’s trading partners. As for the reaction of financial markets, this has been more significant in Russia, Ukraine, and its neighbors, and the central scenario assumes that the most intense effects will continue to be restricted to these countries.

The Board estimates that, if the assumptions in the central scenario prove correct, future increases in the MPR would be smaller than those of recent quarters. Although the MPR increases have been fast and significant, the risks for the convergence of inflation still persist. The Board will carefully monitor these risks, making sure that inflation converges to the target within the two-year monetary policy horizon.

Experts’ two-year inflation expectations as measured by the Economic Expectations and Financial Traders Survey (EES and FTS) have remained above 3% for several months, which is cause for concern. Breakeven inflation also shows high figures over several terms, although in this case their levels are clouded by premiums which, when discounted, reduce them significantly. On the other hand, indicators that measure the perceptions of households and firms obtained from qualitative studies and surveys show the perception that the rise in inflation is a transitory development that will be reversed in a few more quarters. Likewise, firms indicate that, for now, the higher inflation expectations have not significantly altered the dynamics of price formation, while households believe that the adjustments they have already made to their consuming behavior will be sufficient to weather the period of higher price increases.

The central scenario of this Report incorporates more persistent than usual inflation dynamics, partly as a result of expected inflation levels above the inflation target at the normal horizons. This reflects the synthesis of available background information on inflation expectations and the Board’s assessment of their effect on inflation dynamics. In addition, the upper limit of the MPR corridor considers a sensitivity scenario in which the persistence of inflation increases, calling for a stronger monetary policy response than assumed in the central scenario.

The lower bound of the corridor represents a scenario where the contraction of activity and demand is more intense than in the central scenario. The speed at which domestic spending adjusts will be decisive in assessing how quickly inflation converges to the target. This negative trajectory could combine, among other factors, a further deterioration of expectations and labor, and a stronger impact of uncertainty on investment. This sensitivity requires a faster MPR reduction in response to weaker activity than forecast in the central scenario.

In addition to sensitivity exercises, scenarios are analyzed in which changes in the economy would be more significant and where activity would fall outside the range of projections. This time, the Board describes a scenario in which the effects of the war in Ukraine take on much more harmful characteristics for the economy. In this situation, a more severe slowdown or even a global recession could be triggered, in addition to a significant worsening of financial conditions, particularly for emerging countries. However, due to the very uncertainty surrounding the conflict, it is difficult to anticipate what effects would predominate in the MPR decisions should such conditions come true.

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