Central Bank undertakes further reforms to monetary policy to reduce inflationary pressures.  In order to further reduce inflationary pressures, the Central Bank implemented yet another significant monetary policy reform, following the adoption of a freely floating exchange rate regime and the liberalization of foreign exchange restrictions.  In an extraordinary monetary policy meeting on 26 July, the Central Bank decided that the monetary policy interest rate will be defined in relation to Chilean Pesos rather than the inflation-adjusted Unidad de Fomento (UF).  The UF had been widely used before as an indexing unit underlying many contracts and prices.  The nominalization will help to reduce the inflationary pressures resulting from indexing.  In addition, the Central Bank hopes that the measure will reduce volatility in the rates of return and prices of financial assets expressed in Pesos and improve the functioning of Peso denominated financial markets because of both increased transparency.  The measure, which became effective on 9 August, fixes the annual nominal interest rate at 6.5%.  This rate is equivalent to the current annual indexed monetary policy rate of 3.5%, given the Central Bank’s real interest rate target of 3.5% and an expected inflation rate of 3%.

Peso continues to loose ground as Argentina crisis increases uncertainty over future capital flows.  In July, the Peso lost further ground despite the Central Bank’s decision to inject US$ 1 billion into the currency market to prop up the battered Peso on doubts Argentina can pull out of its financial crisis.  By the end of July, the currency had lost some 5.7% nominally against the US$ over June.  This year, the Peso has lost 13.8% and when compared to March 2000, when the current downward slide began, the currency has given away almost a quarter of its value against the US$.  As the uncertainty about the developments in Argentina persists, panellists have applied major adjustments to their exchange rate forecasts.  The Consensus Forecast now sees the year-end exchange rate higher and do not believe that the Peso weakening will revert next year.

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing on Chile.  For more details please click here.

For five-year forecasts, please click here.