Chile - Economic Briefing April 2004

Economy Propelled by Global Rebound and Buoyant Copper Prices (continued)

Outlook improves as domestic conditions improve
The outlook for the Chilean economy is good.  The favourable external setting is now being complemented by improving conditions on the domestic side of the economy.  The improvement in the employment situation and the resulting boost to consumer confidence should buttress domestic demand, which had already picked up notably towards the end of last year.  In addition, the Central Bank has been able to cut interest rates to historic lows in the wake of the strong decline in inflation, which will further boost investment and consumption.  The external sector should provide an even stronger impetus for the Chilean economy in the coming months.  With one third of total activity depending on exports, the economy will profit immensely from the continued global recovery.  Finally, the global rebound is driving up commodity prices, in particular copper.  Consensus Forecast panellists have reflected these positive developments by raising their outlook further from last month’s strong 4.7% a notch to the current 4.8%.  Moreover, growth is likely to remain at this high level in 2005.

Chile enters deflation
It is official: in March, Chile entered deflationary territory for the first time since the 1930s.  In March, consumer prices increased 0.42%.  The reading was in line with expectations but constituted the lowest reading for March since 1998.   Lower prices for housing and household equipment contrasted rising prices for education and recreation and thus mitigated the overall increase.  As a result of the contained price increase in March, the annual headline inflation rate dropped from zero observed in the prior month to -0.7%.  Moreover, core inflation, which eliminates short-term influences from erratically shifting oil prices and fresh fruits and vegetables, corroborates the downward trend.  In March, the core inflation index increased by only 0.35%, which lowered the annual core inflation rate from 0.7% registered in February to 0.3% in March.  Finally, wholesale prices have been in negative territory since October last year and remained unchanged showing an annual decline of 6.7%, despite a significant increase in wholesale prices in March.

Central Bank maintaining interest rates at low levels
The Central Bank had been well aware of the deflationary risks to the Chilean economy and had successively lowered its policy rate to 1.75% in January, the lowest rate ever.  However, in its 11 March meeting, the Central Bank board acknowledged that the drop in core inflation was somewhat larger than expected.  Nevertheless, the Bank expects the monthly price movements to return to normal in the next months amid the pick up in domestic demand and sees inflation reaching its central target of 3.0% within its usual policy horizon of 24 months.  Consensus Forecast panellists share the assessment of the Central Bank and see inflation rising to 2.1% by the end of the year and to 2.8% by the end of 2005.