The Chilean economy has continued with its adjustment process following the major imbalances it accumulated during 2021. Annual inflation, in line with expectations, peaked in the third quarter. Inflation expectations remain above 3% in the two-year horizon. Private consumption continues to contract after the sharp increases it posted in 2021. Investment, on the other hand, surprised on the upside in the third quarter, concentrated in specific sectors, such as renewable energy, which contributed to a widening of the current account deficit in the third quarter. The world economic outlook is complex, given the high persistence of global inflation and rate hikes by the main central banks. The Board has made a significant adjustment in monetary policy, which has contributed to the gradual easing of inflationary pressures and will allow confront these difficulties from a better position. However, the activity gap remains wide and inflation remains well above the target, both signs that the adjustment process of the Chilean economy is yet to be completed. The Monetary Policy Rate (MPR) is at 11.25% and will remain at that level until the state of the macroeconomy indicates that the convergence process of inflation to the 3% target has been consolidated.

In line with expectations, inflation has retreated slightly in recent months, although its level is still high. Demand-side factors have been receding, reflecting the macroeconomic and consumption adjustment. Although still at high levels, the cost factors that gained strength in recent quarters have begun to ease (Box I.1).

In October, the headline CPI variation was 12.8% annually, while core inflation (i.e., without volatiles) stood at 10.8%. Regarding the latter, the rise in its goods component was lower than expected, despite the depreciation of the peso. The increase in the core CPI for services was somewhat sharper, probably due to levels of inflationary persistence that remain high.

Inflation expectations are still high. Two-year-ahead measures persist above 3%, although with some moderation in the margin. In the one-year term, expectations declined somewhat more, to between 4.5% and 6% in the expert surveys (between 7% and 8% at the statistical cut-off of the previous MP Report).

It is worth noting the drop in world transportation costs, the reduction of bottlenecks and the continued normalization of global supply chains. At the same time, international commodity prices have eased. In our November Business Perceptions Report, the firms perceived moderating cost increases, although the volatility and level of the exchange rate remained a factor of concern. In fact, in recent months the nominal exchange rate has continued to fluctuate significantly. Compared to the previous statistical cut-off, the peso depreciated by around 1%.

In general, third-quarter activity data confirm that the economy continues its adjustment process. Non-mining GDP fell by 0.8% with respect to the previous quarter in its seasonally adjusted series, its second consecutive decline. The decline in trade (-2.8% in the quarter) stands out in this result. Business services were the exception (+1.1%), continuing with the growth trend they have followed for several quarters, explained by the outsourcing of activities. The October Imacec confirmed the downward trend of non-mining activity, with a seasonally adjusted 0.4% decline month-on-month.

On the demand side, gross fixed capital formation (GFCF) showed a much better-than-expected performance in the third quarter. This result was driven by investment in renewable energies and other specific sectors. The latter included the impact of engineering works associated with the final phases of mining projects, higher spending on services, and one-off factors such as bus imports.

The outlook for investment is still weak. The latest Capital Goods Corporation survey foresees declining investment amounts during the period 2022-2025. At the same time, business expectations remain pessimistic. The poor dynamism of the real-estate sector also deserves mention. In any case, long-term interest rates and the levels of local uncertainty have diminished in the last few months, which could help somewhat in the future performance of investment.

Private consumption continued to adjust. It is worth highlighting the further decline in durable goods (-3.8% quarterly seasonally adjusted), which has undone a relevant part of the excessive rise seen in the second half of 2021. Meanwhile, the consumption of non-durable goods continues to adjust downwards, while the consumption of services has continued to grow gradually, consistent with the end of supply limitations after the lifting of sanitary restrictions.

Consumption has been adjusting in a context in which liquidity has been normalizing, job creation is slow and real wages have been falling for almost a year. Total employment and the labor force have shown low dynamism during 2022. In the most recent period, the decrease in formal employment stands out, offset by a higher share of informal and self-employment. Some labor market indicators point to a future deterioration. Vacancies have decreased and the employment outlook for companies and consumers remains weak.

The current account deficit rose to 9.9% of GDP in the last moving year, which is high, and associated with both a decrease in private savings and an increase in investment. In a context where consumption has been adjusting, the lower private savings can be largely explained by the negative effect of the worsened terms of trade on national income. The higher investment, as already mentioned, is mainly related to the dynamism of the machinery and equipment component. The still high transportation costs have also contributed. Going forward, it is expected that these phenomena will be reversed via an additional adjustment in consumption and investment, under the assumption that the policies that spurred the sharp fall in national savings will not be repeated.

On the external front, world inflation is still high, but has moderated somewhat in some countries. The high numbers are concentrated mainly in the core component of inflation, which in several economies has been driven by strong services sectors. In the U.S., for example, the continuing tight conditions and high wage pressures in the labor market stand out (Box I.2).

Central banks have reinforced the contractionary nature of their monetary policies, particularly in developed economies, whose monetary adjustment processes began later. The Fed and the ECB, along with significant hikes in their policy rates, have signaled a more protracted tightening than expected a while back. In Latin America, most central banks have continued to raise interest rates, with the exception of Chile and Brazil. Overall, market expectations suggest that rate hike cycles are nearing completion in a significant group of emerging economies. In addition, in several of them rate cuts are expected during 2023, particularly in those that started raising rates earlier. In this context, global financial markets continue to show significant volatility.

The domestic financial market has been adjusting to a lower risk scenario, with a significant drop in nominal interest rates. Compared with early September, 10-year nominal yields fell by 125 basis points (bp). Shorter term rates —1- and 2-year swap rates— fell by around 250bp in the period. At the same time, the spread with respect to international rates decreased significantly. The decomposition of long-term interest rates shows a growing preponderance of external risk factors, while domestic risk factors have decreased. In any case, real rates show movements of a smaller magnitude.

Local bank credit continues to show low dynamism, amid a tight supply and limited demand. The different lending categories show low annual variations by historical standards, with interest rates remaining high. The third-quarter Bank Credit Survey notes that credit granting conditions have become more constrained, amid limited demand.

Structural parameters

As pointed out in September, for this Report the Board updated the structural parameter estimation used in its medium-term projections.

In line with the June 2021 forecast, trend non-mining GDP growth is expected to continue to decline throughout the period 2023-2032. In the nearest years, this trend is related to the fact that some variables, such as hours worked and the participation rate, are already significantly ahead in their post-pandemic recovery. Accordingly, from now onwards they will no longer contribute as significantly to trend growth. Towards the end of the period, the convergence of hours worked to the OECD average becomes more important, which will reduce the contribution of the labor factor. Total factor productivity growth is still estimated to be low, based on the consolidation of a downward trend. In any case, for the period 2023-2032, the trend growth of non-mining GDP will average 2.2% (Box II.1).

The neutral monetary policy rate is estimated to be 3.75%, within a 3.5% to 4% range (+25bp with respect to the previous estimate). This increase is consistent with the recent reversal of neutral rates in other economies, which altered the downward trend shown by international rates (Box II.2).

Projections

The central scenario foresees that headline inflation will continue to decline in coming quarters, to converge to 3% by the second half of 2024. Core inflation is projected to decline somewhat more slowly, reaching 3% by the end of 2024.

Inflation forecast for the end of 2022 and the year 2023 is revised slightly upward with respect to the previous Report. By the end of this year, annual inflation is expected to stand at 12.3% (12% in September). By 2023, total inflation is projected to average 6.6%, ending the year at 3.6% (6.1% and 3.3%, respectively, in September). This revision considers the surprise accumulated in recent months and a slower decline of the real exchange rate (RER) over the projection horizon. Regarding the latter, it is assumed that the RER will remain around its current levels in the coming quarters, contributing to the adjustment of local imbalances, and then begin to decline, in line with the adjustment of imbalances and the convergence of other fundamentals.

The convergence of inflation continues to rely on the further adjustment of the economy. In the central scenario, activity is still foreseen to contract for several quarters. With this, the activity gap will turn negative by the beginning of 2023, remaining at these values until the end of the policy horizon, which is necessary for inflation to converge to the target. In the central scenario, GDP will grow 2.4% in 2022, fall between -1.75% and -0.75% in 2023 and increase between 2 and 3% in 2024. The upward revision for 2022 is based on actual data, while the bulk of the downward correction for 2023 and 2024 responds to the new assumption for trend growth.

The projection continues to assume consumption and investment will see negative variation rates in 2023. This reflects a labor market that has lost strength, pessimistic household and business expectations, a high RER and tighter financial conditions for all credit segments. On the fiscal side, it considers spending in line with the approved budget for 2023, which defines a consolidation path for the following years.

The current account deficit will descend in the coming quarters, in a context where the economy resumes the balance between savings and investment. The reduction in the high transportation costs will also contribute. In the central scenario, the current account will close 2022 with a deficit of 8.7% of GDP, a figure that will fall to 4.9% in 2023 and 4.1% in 2024.

The impulse that the Chilean economy will receive from abroad is reduced from the September forecast. In a context of more contractionary monetary policies in the developed world, global growth prospects have deteriorated again. In the central scenario, in line with market consensus forecasts, the United States and the Eurozone are expected to enter a recession in 2023. With this, Chile’s trading partners will grow 2.1% next year (2.6% in September). Commodity prices are still expected to be on a downward trajectory with respect to their current levels. For copper, average prices of US$3.55 and 3.45 are foreseen for the next two years, and for oil, prices of around US$80 are forecast for the same period.

Monetary policy has made a significant adjustment and is facilitating the resolution of the imbalances present in the economy. However, inflation remains very high and its convergence to the 3% target is still subject to risks. The Board will maintain the MPR at 11.25% until the state of the macroeconomy indicates that this process has been consolidated.

The borders of the MPR corridor reflect scenarios where the speed of the inflation convergence process allows for earlier or later adjustments of the rate with respect to the central scenario estimate. A relevant factor is the assessment of inflationary persistence, either by the magnitude and sign of new inflation surprises or by the degree of adjustment of expectations. Scenarios where these variables denote a lower (higher) inflationary persistence could lead to a sooner (later) than expected process of MPR reduction. Another relevant factor would be the speed of the economy’s adjustment. The external scenario has seen steady deterioration, and household and business expectations are in pessimistic territory. In this context, a faster adjustment of the economy leading to an earlier reduction of the MPR cannot be ruled out. In any case, the opposite scenario cannot be ruled out either, since demand, particularly investment, has been slightly more dynamic than expected in recent times. The Board estimates that the lower and upper bounds of the MPR corridor, respectively, capture the alternative MPR trajectories associated with these events.

As for risks, the external scenario has become a major source of concern and events leading to a major disruption of financial conditions and an abrupt deterioration of external impulse should not be disregarded. In such case, the short-term inflationary effects could be considerable —due to the global appreciation of the dollar—, although mitigated in the medium term by their impact on growth. On the other hand, measures that prevent the expected adjustment in spending, and give a new impulse to inflation, would lead to MPR hikes to ensure the convergence of inflation to the target.

The Chilean economy is in the process of resolving its macroeconomic imbalances and has the task of rebuilding the buffers that have allowed it to mitigate the impacts of external shocks in the past. For the same reason, it is particularly important that all economic policies point in the same direction, and that priority be given to those aimed at promoting savings. The economy’s ability to make a rapid, orderly adjustment at the lowest possible cost depends critically on the coherence of the decisions of the different agents involved. In the case of the Central Bank, the Board will keep the monetary policy rate at its current level until the state of the macroeconomy indicates that the convergence process of inflation to the target has been consolidated.