SANTIAGO Chile's slower pace of economic growth and soft inflation are opening up more monetary policy possibilities, but other factors must be considered and the stance on interest rates is still neutral, the central bank's president said on Friday.
Asked why medium-term market expectations had recently shifted from a rate hold to a cut, Central Bank President Rodrigo Vergara told the Reuters Latin America Investment Summit that "there are some factors that in some way open up the spectrum of possibilities towards some (options) that weren't present, in particular the option of a rate cut."
"What's happened in terms of inflation and in terms of activity obviously opens up more possibilities, but there are a series of elements that we still need to evaluate," Vergara added.
Traders see the central bank cutting its benchmark interest rate by a quarter-percentage point to 4.75 percent within 12 months, shifting from their view of no change in the interest rate over the next two years, a central bank poll released on Wednesday showed.
If signs of slowing economic growth and domestic demand "consolidate, evidently an option of that nature becomes stronger. Another factor is below-target inflation," Vergara said.
Chile's economic growth eased in the first quarter to 4.1 percent compared with a year earlier, its slowest pace of expansion since late 2011, official data showed on Monday.
The bank has forecast 4.5 to 5.5 percent economic growth for world No.1 copper producer Chile in 2013. On Monday it left its gross domestic product growth for 2012 unchanged at a 5.6 percent expansion.
Meanwhile, inflation in the 12 months through April came in at 1.0 percent, below the bottom end of the central bank's 2 to 4 percent tolerance range.
"In general we see elements that are transitory so we project that inflation will gradually move back to 3 percent and when I say gradually, it's very gradually because we believe it won't be during this year, but will probably be during the first half of next year," Vergara said.
The bank forecasts annual inflation will end the year at 2.8 percent.
"If before we saw risks leaning towards the domestic front, an excess in domestic demand, today we now see that equilibrium has been reached with the external risks," Vergara said.
Chile has held its benchmark interest rate at 5 percent since a surprise cut in January 2012 as robust local economic growth, low inflation and ebullient domestic demand have countered external economic threats and kept the bank's hands tied.
"We consider 5 percent from a medium-term macroeconomic stability point of view as ranging around neutral ... but it is also true that our monetary policy rate is now considerably high compared to other countries," Vergara said.
In monetary policy parlance, a neutral rate does not spur or slow growth with all other factors being equal.
Earlier this year the bank had flagged the possibility that domestic demand growth would continue to outpace GDP expansion, and therefore help fuel a widening current account deficit, as the main local risk to Chile's economy.
Local demand, which expanded 6.8 percent in the first three months of the year, "is slowing, but still growing at a high rate," Vergara said.
While strong domestic demand growth posing a risk to Chile's economy is still one of the bank's scenarios, "the likelihood of that scenario happening has diminished and in that sense, I think it's good news," the central banker added.
In any case, the current account deficit, which is forecast to increase to 4.4 percent of GDP this year is still a source of concern.
"But of course if amid this slowdown, which is preliminary and just starting, we see domestic demand consolidate then it's possible that this risk diminishes, but for now we still consider it a relevant risk," Vergara said.
The current account deficit grew roughly three-fold last year to $9.497 billion, equivalent to 3.5 percent of annual GDP, as the surplus in the nation's trade balance fell sharply.
PESO STILL A CONCERN
Vergara said that despite the peso's recent depreciation, "the exchange rate is still of concern for the central bank."
Chile's apparent economic easing, falling prices for its top export copper and the possibility of a reduction of monetary stimulus in the United States have relieved pressure on the peso, whose strength has been a major headache for exporters in the commodities-dependent nation.
The currency has retreated from the 1-1/2-year high in April, when it was buoyed by Chile's robust economy, an attractive rate differential and copper prices. Earlier this week it slumped to a 10-month low.
Vergara said the possibility the U.S. Federal Reserve could curb its purchasing of Treasuries and mortgage-backed securities would be somewhat of a relief for emerging economies that have faced capital inflows and appreciating currencies.
The Fed's stimulus program has been a boon to equities markets and other riskier assets.
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(Writing by Anthony Esposito; Editing by Chizu Nomiyama, Andrew Hay and Bob Burgdorfer)