MNI INTERVIEW: Chile Faces Wage-Price Risk – Ex-C. Bank Chief

The Chilean economy faces the risk of a difficult-to-contain wage-price spiral, potentially requiring additional hikes in official interest rates on the order of 200 basis points or more, former central bank governor Jose De Gregorio told MNI.

“I wouldn’t rule out more persistent inflation,” said De Gregorio, who served as central bank chief from 2007-11 and is now dean of the business school at the University of Chile.

Chile’s economy is forecast to have surged nearly 12% higher in 2021, one of the highest growth rates in the world. But inflation was 6.7% in the year to November, well beyond the central bank’s target of 3% plus or minus one percentage point.

“We may face the risk of a wage-price spiral, and that’s difficult to contain in a country where, although we haven’t had very high inflation in the last 30 years, there is a history of inflation – it was a high inflation country,” De Gregorio said in a telephone interview from Santiago, echoing similar concerns about the United States.

“Inflation expectations are still well anchored, but you never know what the inflation expectations of the financial system really are.”

Chile’s central bank hiked interest rates four times this year for a total of 350 basis points, and the target rate is now at a seven-year high of 4%. But that’s clearly not enough, De Gregorio said, adding that the terminal level for official rates will depend on the path of inflation.

“I think the central bank will keep tightening and slow the economy, not in a dramatic way. There is a concern with an unanchoring of inflation expectations – we already had problems in the late 2000s,” he said.

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That means hiking official borrowing costs some 200 basis points further, potentially a lot more, he said.

“I wouldn’t rule out that it goes up to 6%, up a couple of more points, in an environment in which inflation would still be kind of tightening. I say 6% but it could perfectly go to 8% if inflation persists.”

Chile’s central bank warned rates will have to stay elevated for an extended period as it raised its 2021 inflation forecast more than a percentage point to 6.9%, saying it will not likely hit the 3% inflation target until 2023.

Global supply chain pressures and booming prices for commodity exports have been major drivers of Chilean inflation, De Gregorio said, as well as domestic demand and a depreciating peso.

The currency factor, however, may be more closely linked to politics than anything else, De Gregorio said. A surprise leftist presidential victory, after years of rising social tension in a country where income inequality remains high despite increased living standards, raised concerns among investors. But the president has so far exhibited a market-soothing circumspection, promising to maintain fiscal discipline.

“There has been some strengthening in the peso because the president-elect has been quite moderate,” he said.

Chile’s low levels of government debt also shield it better from any potential harm from Federal Reserve interest rate hikes than most of its peers.

“Chile is a country that has a very low level of public debt and a very strong financial system, so we’re one of the last in line to suffer a crisis,” he said. “I wouldn’t worry that Fed tightening could have serious problems for the Chilean economy.”