Chile - Economic Briefing February 2004

Sun Shines Brightly over Economy (continued)

Outlook improves as domestic conditions get better
The favourable external setting is complemented by improving conditions on the domestic side of the economy.  In particular, the declining unemployment and the resulting improvement in consumer confidence promises to lift domestic demand.  Moreover, the Central Bank has been able to loosen monetary policy substantially as a result of the strong decline in inflation.  In December 2003 and in January 2004, monetary authorities cut the lending rate a full percentage point to a record low of 1.75%.  With interest rates at historic lows, investment and consumption are bound to experience an additional boost.  Consensus Forecast panellists have reflected the improved setting by lifting their outlook for economic growth this year a notch over last month to 4.7%.  Moreover, growth is likely to remain on such a high level.  Consensus Forecast panellists believe the economy will grow at the same pace in 2005.

Inflation drops further to multi-decade low
In January, consumer prices dropped 0.19%.  While the market had already anticipated a decline, the extent of the drop in consumer prices came as a surprise since the market had anticipated prices to fall by a more moderate 0.11%.  The decline is consumer prices was broad based and seized six of the eight categories observed by the National Statistical Institute (INE), with housing and transport marking the exception.  Lower food prices, in particular fruits and vegetables, constituted the main driver behind the price decline in the first month of the year.  The core inflation index, however, which excludes fuels as well as fresh fruits and vegetables, dropped 0.15% in January.  The omission of lower prices for fresh fruits and vegetables was offset by higher fuel prices which inflated headline inflation but were not included in the calculation of the core index.  As a result of the January price drop, annual headline inflation declined from 1.1% at the end of last year to 0.8%.  This rate represents the lowest annual inflation rate registered since 1935.  The rate is now only a fraction of the 3.0% targeted by the Central Bank.  In fact, Chile faces the danger of entering in deflation.  Of the past ten months, only two have registered positive price developments.  Core inflation is only marginally higher, since the rate has continuously dropped over the past months from 3.1% registered in April 2003 to 1.5% in January.  Nevertheless, Consensus Forecast panellists expect the pickup in domestic demand to exert new pressures on consumer prices and see headline inflation rising to 2.3% by the end of the year, which is down 0.2 percentage points from last month’s forecast.

Peso experiences volatile trading
In January, the peso remained virtually unchanged versus the US$.  After a strong first half of the month, which took the peso from the 599 pesos per US$ by the end of 2003 to 559 pesos on 13 January, the Chilean currency began to weaken.  Shortly after the Central Bank’s decision to apply the second interest rate cut in two months on 8 January, the peso began to depreciate despite ongoing strong copper prices, ending the month at 597 pesos to the US$.  Consensus Forecast panellists expect the currency to end the year at 609 pesos to the US$.  Exchange rate stability will also carry over into 2005, when the currency is expected to depreciate only marginally to 621 pesos to the US$.