Consumer prices fell by 0.2% month on month in June, according to the Banco Central de Chile (BCCh, the central bank). This came as a surprise: EIU’s expectation—and the consensus view—was that prices would rise. The June result reflects the significant impact that currency appreciation, an easing of commodity prices and a cooling of demand in the economy have had on inflation amid a tight monetary policy environment. We now expect the BCCh to cut its policy rate aggressively, by 75 basis points, at its next meeting on July 28th.

The decline in prices in June, which took the BCCh and markets by surprise, reinforces our call that the central bank will begin its easing cycle in July, although it also suggests that the BCCh will take a more aggressive approach than we had anticipated. We now think that it will cut the policy rate by 75 basis points, rather than by 50 basis points (as under our previous forecast). The June inflation figures show a broad-based slowdown in prices: only 42% of products in the price basket registered price increases—below the average of 57% over the previous five months and lower than 54% a year earlier. More importantly for the BCCh, core prices remained unchanged. The shift to disinflation partly reflects peso appreciation and an easing of commodity prices, which caused prices of tradeable goods to fall. Prices for non-tradeable goods increased, but at a slower pace, as the lagged impact of the BCCh’s tight monetary policy manifested itself in softer domestic demand.

We think that the June result will prompt the central bank to kick off its monetary‑easing cycle with a large 75‑basis‑point cut this month. The BCCh held the rate at 11.25% at its last meeting, but the committee was split, with two of the five members voting for a 50‑basis‑point cut. Impetus for a rate cut will also come from two‑year‑ahead inflation expectations, which have declined and are now anchored again at the BCCh’s 3% inflation target. As inflationary pressures are now abating, we believe that the BCCh will pivot to supporting economic growth, which has slowed this year amid a high interest-rate environment.

We now expect the policy rate to end the year at 8.25% (from 9.25% under our previous forecast). Nevertheless, there is a risk that the BCCh will bring down rates even more aggressively than we expect; cuts of 100 basis points are quite possible this month and in September.

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