MNI INTERVIEW: Chile Rate Cuts Should Resume- Ex-Deputy Garcia

MNI (BRASILIA) - The Central Bank of Chile should resume its strategy of cutting rates to meet its inflation target after holding borrowing costs in July, former deputy governor Pablo Garcia told MNI, noting that officials will have to balance financial market volatility with downside risks following weaker-than-expected second-quarter growth.

Last month, the BCCh’s board unanimously held the monetary policy interest rate at 5.75%, despite widespread expectations for a 25 basis-point cut. Garcia, now a professor at Adolfo Ibanez University, highlighted in an interview that the board had already indicated that pauses were likely to occur after an aggressive start to its rate-cutting cycle from a peak of 11.25%.

"Given the current level of interest rates, the decision on when these pauses should happen is not obvious and is part of the deliberations the Council surely has. The market was somewhat divided, with some indicators suggesting a hold and others a 25bp cut. Overall, I share the view that an interest rate path with cuts on the horizon is the right one," said Garcia, who left the board in January after 10 years.

Factors likely to be considered by the board in its September meeting include weaker-than-anticipated second-quarter activity data, China’s growth deceleration, tight financial conditions, and a possible Fed rate cut, he said.

"Given these factors, I believe that continuing the monetary policy easing is the appropriate strategy to bring inflation back to the target within the two-year horizon.”

MONETARY NORMALIZATION

Garcia recalled that in June, the central bank estimated that monetary policy normalization to the neutral rate could be reached by the first half of 2026, with neutral currently estimated in a range of 0.5% to 1.5% in real terms. (See MNI INTERVIEW: Latam Neutral Rates Stable Through Pandemic)

"The discussion on the neutral rate is complex because it is an unobservable variable," Garcia said. "What was shown in the June monetary policy report is that the interest rate reaches near that neutral level by the first half of 2026. I don't expect anything significantly different in the September document, because it is natural to anticipate a normalized economy over the next two years.”

Chile’s annual inflation increased for the fourth month in a row in July, reaching 4.6%, the highest since November and up from 4.2% in June. The central bank targets inflation of 3%.

Further upside risks to short-term inflation are related to supply shocks, such as electricity tariffs, while downside risks stem from demand shocks due to greater domestic weakness and a less favorable external scenario, Garcia said, stressing that the medium-term risks are more relevant to monetary policy. (See MNI POLICY: BCB Divided Over Risks To Inflation)

Chile’s third-quarter growth will be key, he said. "If a significant portion of the second-quarter slowdown is not reversed, we could be in a weaker cyclical scenario."

FED IMPACT

Amid expectations for more aggressive Fed cuts this year, the former deputy noted that the impacts on Chile's economy could vary depending on the reasons behind them.

"BCCh's monetary policy is independent of the Fed, but relative movements depend on the degree of synchronization between their own activity and economic cycles. The question for the U.S. is whether there will be a severe recession with negative implications for financial markets or a mild slowdown," he said.

"Depending on the nature of the more intense Fed rate cuts, the implications for Chile could be quite different, including for the exchange rate.”