Chile’s central bank raised its key interest rate by 75 basis points to 9.75% on Wednesday, meeting the forecast of some economists but falling short of matching what was priced in by the swap rates market. Before the decision, the curve priced in more than a full percentage point hike, as the peso’s selloff over the last month led investors to bet on a more aggressive response from policy makers.
The outlook for the peso will depend on copper prices if policy makers don’t act, according to Vivanco, who predicted a 150-basis point rate hike. Seven of 21 analysts surveyed by Bloomberg forecast a 75-basis point move, while another 11 had expected a smaller increase of 50 basis points and two were betting on a full percentage point move.
The peso, in the meantime, is down almost 18% versus the dollar over the past month and more than 20% since reaching a peak in early June. This has prompted Credit Agricole to call for borrowing costs to rise to “punishing levels” to prevent a currency crisis in the absence of more direct intervention in the foreign exchange market.
Chile’s central bank has now raised interest rates 9.25 percentage points in the past year. Yet, inflation has continued to accelerate, reaching its fastest pace since 1994 and with no signs of slowing to the target any time soon. Economists surveyed by the central bank raised their forecast for year-end inflation to 11% from 10% in a poll released Tuesday, and their 2023 prediction to 5.1% from 4.6%.
The currency tumbled as much as 4.9% to an unprecedented 1,060.40 per dollar, on course for the worst day since 1989 on a closing basis. Two-year local swap rates erased an initial drop to rise as much as 37 basis points, as traders bet policy makers will have to take a more hawkish stance in the future.
“Traders were waiting for more. The central bank is losing credibility,” said Alvaro Vivanco, head of emerging-market strategy at NatWest Markets. “Arguing that it is all about the dollar and Chinese growth when the peso is the worst EMFX performer will not do the trick.”
Chile’s central bank isn’t showing signs it will intervene into the foreign-exchange market despite a rapidly declining peso, according to Goldman Sachs. Economists including Sergio Armella wrote in a note Thursday the nation’s policy makers noted markets have been able to properly absorb shocks and that foreign-exchange market volatility has not been transmitted to other parts of the financial system.
Copper, the nation’s main export, has dropped nearly 30% since a peak in early June amid fear of a global slowdown and as China extended mobility restrictions to contain the spread of new coronavirus infections. According to Barclays, Chile is in the worst position among emerging markets to withstand significant portfolio outflows.
“FX weakness has been the catalyst for the market to price in higher rates for longer,” Barclays strategists Erick Martinez and Gabriel Casillas wrote in a note Thursday. “The rates market seems to be incorporating additional upside inflation risks through the channel of FX pass-through to inflation.”