SANTIAGO (Reuters) - Chile’s central bank cut its benchmark interest rate by a quarter of a percentage point to 4.75 percent on Thursday in a surprise move to stimulate the Andean country’s easing economic growth.
The bank cited a consolidation of “slower world growth, lower terms of trade for Chile, less favorable financial conditions and the maturing of the global cycle of mining investments” as well as expectations that domestic demand, one of the economy’s key drivers, will wane.
Few in the market had expected the bank on Thursday would break the wait-and-see position it had adopted since a cut to its key rate in January 2012.
“This is an adequate measure justified by many internal and external factors,” Finance Minister Felipe Larrain said. “The cut will contribute to maintaining a competitive exchange rate, boosting the export sector and offsetting the effects of lower domestic demand.”
The reduction is likely to weaken the peso and affect the local bond market, analysts said. Several added they are pricing in further cuts in coming months, though a hypothetical easing cycle is likely to be gradual.
“The (central bank) was not very successful, at least in the communiqué, in explaining ‘why now,’ which is the major surprise,” Nomura’s George Lei said in a note to clients. “We continue to believe this cut signals the beginning of an easing cycle, which should eventually take the TPM (monetary policy rate) to 4 percent. We also believe the next cut will be data-dependent, not just on past data but more importantly on forward-looking measures.”
Chile’s strong economic growth has been easing on the back of cooling investment and domestic demand. The bank is forecasting growth of between 4 percent and 4.5 percent this year, down from 5.6 percent in 2012. Price pressures have largely remained contained, with inflation in the 12 months to September reaching 2.0 percent, at the low end of the bank’s 2 to 4 percent target range.
“Domestically, economic activity has proceeded at a moderate pace, in line with the scenario in the last Monetary Policy Report,” the bank’s post-meeting statement said.
"Final demand has reduced its rate of expansion, although not as sharply as was forecast. Various indicators anticipate that it will decelerate further," the bank added. (Bank's statement: r.reuters.com/dav83v)
The bank did not explicitly mention further reductions.
“It suggests they will proceed slowly. Perhaps they’re letting the market know a movement won’t happen next month,” said Luis Felipe Alarcon, economist with BCI in Santiago. “It will depend more on what they say in the quarterly monetary policy report (IPoM).”
The cut comes just a month before the November 17 general election, which is expected to mark the return of the center-left. The ruling right-wing has largely been unable to capitalize on robust economic growth during President Sebastian Pinera’s term.
Small, export-dependent Chile is highly sensitive to a gloomier global economic outlook and especially to what happens in China, its top trade partner and the world’s leading metal consumer.
Copper prices have shed 9 percent so far this year on fears of easing global demand. A potential big production surplus next year has sparked fears prices could take a further hit.
Over half of Chile’s export revenue stems from copper. One job in mining is estimated to create three additional ones in the Andean country, the world’s largest copper producer.
Though Chile also exports wood pulp, wine, salmon and fruits, its economy remains overwhelmingly copper-dependent and therefore tied to the health of the global economy.
Many experts have warned Chile, as well as its export-dependent Latin American peers, to diversify its mining-based economy.
The move to ease monetary policy in Chile compares with regional powerhouse Brazil, where the central bank raised its benchmark Selic interest rate for the fifth straight time last week, keeping the pace of rate hikes steady and giving no signs it was ready to end monetary tightening to battle high inflation.
Farther north in Mexico, the central bank has cut its benchmark interest rate twice this year to a historic low of 3.75 percent in a bid to boost sagging growth in Latin America’s second-largest economy.
Previous to Thursday’s meeting, analysts polled by the Chilean central bank had forecast the rate would be kept steady at 5.0 percent in October and in November, but would be cut by 25 basis points in December.
Reporting by Alexandra Ulmer, Anthony Esposito, Antonio de la Jara, Fabian Cambero, and Felipe Iturrieta; Writing by Alexandra Ulmer and Anthony Esposito; Editing by Andrew Hay, Richard Chang, Carol Bishopric and Lisa Shumaker