Inflation has declined rapidly and now stands closer to 3%. Data from the beginning of the year show some increase in annual inflation, in a context where activity has exceeded expectations somewhat, and consumption and investment ended 2023 slightly below previous estimates, particularly in their tradable components. The postponement of the rate cut in the U.S. and the slower process of reductions by central banks elsewhere have had an impact on Chile’s rate differential with other economies. Together with the evolution of its other fundamentals, this has caused the peso to depreciate. Coupled with the recent rise in some international prices, these factors will push up annual inflation in 2024. It is expected to converge to the 3% target within the two-year monetary policy horizon, which considers the transitory nature of the aforementioned elements, that the economy will see expansion rates consistent with its trend, and a gradual decline in the real exchange rate (RER). For this year, GDP growth is expected to be between 2% and 3%, with a range between 1.5% and 2.5% for 2025 and 2026. The Board foresees that, in line with the central scenario of this MP Report, the Monetary Policy Rate (MPR) will be further reduced. The magnitude and timing of the MPR reduction process will take into account the evolution of the macroeconomic scenario and its implications for the trajectory of inflation.

Inflation dropped rapidly from its 2022 peaks and is now closer to the 3% target. This occurred in the context of an adjustment in domestic spending and a reduction in the activity gap, which contributed to resolving the large macroeconomic imbalances of previous years. In this scenario, two-year inflation expectations have remained at 3% for several quarters now.

The process of inflation decline has been heterogeneous across its components, with a faster decrease in goods than in services. This is consistent with bigger gaps in those sectors representing goods than services consumption, a moderate pass-through of the exchange rate depreciation —in line with wider gaps in tradable sectors— and the significant relief of global cost factors in previous years. For its part, the relevance of indexation processes in the inertia of service inflation stands out.

Inflation ended 2023 below the levels projected in the previous MP Report. In December, inflation was unexpectedly low, resulting in the annual variation of total and non-volatile CPI closing the year at 3.9% and 5.4%, respectively (4.5% and 5.8% in the last MP Report). The difference between what was estimated in the last MP Report and the actual figure was even greater after the change in the CPI basket and methodology was published. The monthly variations of both the total and core indicators showed uneven dynamics between both baskets, especially in the first part of the year, while in the second half it was similar.

At the turn of 2024, inflation accelerated with higher-than-expected figures, and its evolution must continue to be monitored. Both January and February had high monthly CPI variations above expectations. Among other factors, this was due to the peso depreciation, world price increases and indexation of some local prices. Moreover, they occurred in a context in which monthly inflation has shown greater volatility in recent months. As a result, the annual variation of the total CPI rose to 3.6% in February, while core CPI inflation fell to 4.2% /.

The recent behavior of inflation occurs in a context where both the mining and non-mining components of the Imacec posted slightly better than expected results in January and February. This combines several elements, namely: higher external demand, reflected in the growth of some manufacturing and agricultural lines; supply factors, such as the higher value added of power generation; and some items associated with a greater local impulse, as seen in services. This dynamic would have increased the GDP of the first quarter. Given the transitory nature of some of the aforementioned elements, the central scenario anticipates a slower pace of growth in the coming months, in line with those considered in the previous Report /.

In the second half of 2023, final demand was somewhat weaker than projected, particularly in its tradable components. The 2023 National Accounts showed that the deseasonalized series of household consumption fell up to the third quarter, with a faint recovery towards the end of the year. This resulted in a higher-than-expected annual contraction: -5.2% (-4.6% in the December MP Report). In turn, gross fixed capital formation (GFCF) showed a sharp reduction in the last quarter of the year. This was the case especially in the machinery & equipment component, which tends to show high volatility and was affected by the exchange rate depreciation. Still, its 2023 drop was less than expected (-1.1%; -1.9% in the December MP Report), due to the upward correction of its levels in the first quarter of that year.

In the external scenario, global inflation has continued to ease. Anyway, there are some risks due to the reversal of cost factors and the persistence of high inflation of service items. Although lower than a few quarters ago, transportation fares and fuel prices have been rising over the course of the year, influenced by developments relating to the conflict in the Middle East.

Doubts about inflation focus especially in the U.S. economy, whose resilience stands out, sustained by the dynamism of its labor market and private consumption. Activity growth in this country was well above forecasts of a few quarters ago and employment indicators have exceeded expectations, maintaining a tight labor market. This, in a context of continued contribution from public spending and improved performance of investment at the margin.
The greater dynamism of the U.S. economy, together with recent inflation figures somewhat higher than expected, have led the Federal Reserve (Fed) and the market to believe that interest rate cuts will be postponed to the second half of the year. The Fed has maintained the Fed funds rate flat at its recent meetings and, although it reiterated that there were three 25 basis point (bp) cuts to be made this year, it also anticipated fewer cuts in the next two years. All this has affected the performance of different financial variables, including a dollar appreciation worldwide.

The postponement of benchmark rate cuts in the U.S. and the slow process of reductions in other central banks have affected Chile’s rate differential with other economies, in line with the lag of their business cycles. These divergences have been adding greater pressure than anticipated on the peso’s performance, along with the movement of the rest of its fundamentals. Compared to the beginning of the year, the peso has depreciated around 12% against the dollar and close to10% in multilateral terms (MER).

The reduction in the MPR has been passed on to the cost of local financing, in line with the normal transmission of monetary policy. Interest rates have fallen especially for shorter-term loans —mainly commercial—, while longer-term loans continue to be influenced by the persistence of high long-term rates. In parallel, credit risk has increased, as suggested by indicators of delinquency and provisions, among others. On the other hand, some sectors still face restrictions in accessing a loan, as indicated by various sources of information, including the Business Perceptions Report (BPR).
Projections

The outlook for inflation is revised upward, especially for 2024. As of December of this year, annual headline and core inflation are estimated to reach 3.8% (2.9% and 3.2% in the last MP Report, respectively /).

This adjustment is influenced by the depreciation of the exchange rate, the deterioration of global cost factors in recent months —including the price of oil— and higher inflation early in the year. In the medium term, among other elements, the convergence of inflation to the target considers that the economy will not exhibit significant imbalances and that the RER will decline gradually. The intensity of this decline will be subject to the unfolding of financial conditions. This scenario assumes a moderate coefficient of exchange rate pass-through to final prices, in line with what has been observed in the most recent period and with a still weak demand for tradable items.
GDP growth is foreseen to be between 2% and 3% this year (1.25%-2.25% in December). Much of this revision is explained by the acceleration of activity in the first quarter. As some of its transitory elements reverse, activity will resume growing at a slower rate, matching previous forecasts.

For 2025 and 2026, growth is projected to range between 1.5% and 2.5%, with the economy converging to its potential growth rate. The improved performance in early 2024 involves a somewhat larger activity gap in the immediate future, but in the medium term it will remain around its equilibrium point.

Private consumption will expand at near the rates considered in December. Its foreseen path —and that of the other components of demand— considers the lowest starting point of late 2023. Going forward, household spending will gradually increase, consistent with high-frequency data. This will be supported by increasingly more favorable financial conditions and the rebound in the real wage bill driven by rising real wages and employment. The labor market still exhibits some slack, although it is estimated that part of the lag in the participation of certain age groups may be more permanent. Consumer confidence has been improving (IPEC), yet it persists in pessimistic ground.

GFCF will show a contraction again in 2024, due to a higher comparison base, its evolution towards the end of 2023, and still weak fundamentals. Some background data point to a continued deterioration of GFCF in the near term, especially in machinery and equipment. Imports of capital goods have weakened further, amid the exchange rate depreciation of recent months. Projections consider that in the first half of the year the speed of expansion of this fraction of GFCF will be less negative than it was at the end of 2023 and that it will turn positive in the second half of the year. In any case, it is important to bear in mind that this is a traditionally volatile component of expenditure. In construction and other works, the greater momentum of engineering works projected by the surveys is opposed by a low dynamism of the real estate sector. Financial conditions continue to hold back investment, especially due to the interest rates on longer-term loans.

The current account deficit will be 3.4% during 2024-2026. The improved projection for this year and next especially incorporates the effect of exchange rate depreciation and greater external demand on exports, as well as the impact of the weakness of domestic spending on imports.
Higher growth foreseen for the U.S. in 2024 contributes to having a stronger boost from abroad. The central scenario assumes that in 2024 this economy will grow more than anticipated in the last MP Report (1.9%; 0.6% in December) and rules out the possibility of a recession. This correction explains about two thirds of the adjustment in the outlook for Chile’s trading partners this year (3%; 2.7% in December). For the rest of these countries, the projections confirm low growth. Doubts about China stand out, where growth is still expected to slow down this year and in some years to come. In any case, China’s demand for copper remains strong, thanks to growing role in the renewable energy transition and electromobility, which raises the estimate for the copper price (US$3.85 per pound in 2024-2026).
Monetary policy

The local economy has succeeded in closing the significant macroeconomic imbalances of previous years, inflation has declined rapidly and stands closer to 3%, while inflation expectations are aligned with the target. However, rising inflation figures at the beginning of the year and higher imported cost pressures emphasize the need to continue closely monitoring its evolution. To the extent that the shocks that affect inflation are transitory, the monetary policy framework based on a two-year target allows them to be accommodated within the policy horizon without putting inflationary convergence at risk.

The Board foresees that, in line with the central scenario of this MP Report, the MPR will be further reduced. The magnitude and timing of the MPR reduction process will take into account the evolution of the macroeconomic scenario and its implications for the trajectory of inflation.
The sensitivity scenarios (i.e., the borders of the MPR corridor) consider situations where the evolution of domestic demands diverges from projections in the central scenario. The upper bound incorporates a better performance of spending that would encourage price increases and a re-composition of business margins, creating a more inflationary outlook. The lower bound presents a further deterioration of domestic demand. For example, there could be a slower recovery of some economic sectors, with their respective repercussions on the labor market, which would mitigate pressures on inflation.

The main risks —scenarios that go beyond the limits of the MPR corridor— are still mainly linked to external front. Worth noting is the deteriorated global geopolitical situation. Other areas of concern are the weak Chinese economy and the vulnerability of its real estate sector, doubts about the U.S. fiscal situation and possible financial disruptions associated with the evolution of commercial real estate sector worldwide.
The world economic scenario is subject to higher-than-usual degrees of uncertainty. In particular, because there are still questions about the Fed’s benchmark rate cut process, in addition to doubts regarding the economy’s fiscal situation. In this context, the discussion about the evolution of global financial conditions continues, especially with respect to long-term interest rates and their relationship with the levels of neutral rates.

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