Chile - Economic Briefing January 2004

  Rising Hopes Amid Global Rebound (continued)

Inflation drops to historic lows in December
In December, consumer prices dropped 0.32%.  While the market had already anticipated a decline in consumer prices, the extent of the drop came as a surprise since the market had anticipated prices to fall by a more moderate 0.13%.  The decline is consumer prices was broad based and seized all categories observed by the National Statistical Institute (INE) with the exception of education and recreation, where prices increased.  Lower transportation costs and food prices constituted the main drivers behind the year-end price decline.  Hence, the core inflation index, which excludes fuels and fresh fruits and vegetables, dropped only 0.11% in December.  As a result of the year-end price drop, annual headline inflation came in at 1.1% at the end of the year.  According to INE, this represented the lowest annual inflation rate since 1935 and is less than half the 2.3%, which had the last marked a multi-decade low in 1999.  The rate is also below the 3.0% projected by the Central Bank.  In fact, Chile faces the danger of entering in deflation.  Of the past nine months, six registered negative price developments.  Core inflation, which excludes the sizeable impact of oil prices, is only marginally higher, as the core inflation rate continuously dropped from 3.1% registered in April to 1.6% by the end of the year.  By the end of 2004, Consensus Forecast panellists expect headline inflation to rise to 2.5%, half a percentage point below the 3.0% rate expected by monetary authorities.

Central Bank cuts interest rates
The Central Bank has taken the benign inflationary developments into account and further loosened the monetary strings.  On 11 December, the Central Bank Board unanimously opted to cut the benchmark lending rate, already at a record low, by a half percentage point, from 2.75% to 2.25% and on 8 January, the Bank repeated the move, cutting another 50 basis points to 1,75%.  In the official statement, the Bank acknowledged the possibility that annual headline inflation could drop into negative territory in the first half of 2004.  The move is designed to close the gap with the inflation target rate over the next 24 months, which the bank maintained at the usual 3.0%.

Peso continues to strengthen
Despite the relatively large interest rate cut, the peso continued its appreciation trend observed from March of last year, when the currency had reached a historic low at 758 pesos per US$.  In December, the currency appreciated another 4.2% in nominal terms versus the US$, finishing at 599.4 pesos to the US$.  As a result, the accumulated nominal appreciation versus the US$ reached 18.8% over the year, the highest rate in more than a decade.  The strength of the peso was based on the more positive outlook for the Chilean economy and the rapid increase in copper prices in the final three months of 2003.  In 2003, the copper price increased 51.1% from US$ 1,536 per tonne to US$ 2,321 per tonne (105 cents per pound) at the end of the year.  This is also good news for the budget since the Chilean state relies to a large part on revenues from the mostly state-owned copper industry.  The budget for 2004 assumes a copper price of 83 cents per pound.  Consensus Forecast panellists have continuously lowered their exchange rate forecast over the past months and are likely to continue to revise their exchange rate forecasts if the underlying fundamentals – mainly a higher copper price – persist.  Currently, the Consensus sees the exchange rate at 621 pesos to the US$ by the end of 2004.  The export sector already is beginning to complain about the strength of the currency and is concerned that the current appreciation trend may jeopardise the competitiveness of Chilean goods in the rebounding global economy.  Nevertheless, the Central Bank confirmed its intention not to intervene in the foreign exchange market to slow the appreciation of the peso.  Since 1999, the peso has been floating freely and the Central Bank has intervened only in exceptional cases of short-term turbulence, such as following the Argentine devaluation and Brazil's financial crisis last year.