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Thursday, August 14, 2008

Chile's Central Bank Raises Interest Rates

Chile's central bank raised its target interest rate to 7.75 percent yesterday. This is now the highest level in almost a decade, and marks the strength of the determination at the central bank to slow Chile's inflation back down towards the bank's target zone. Central bank President Jose De Gregorio and his team boosted the key rate by half a percentage point for the third straight month, making borrowing costs the highest since December 1998.

Consumer prices rose at an annual pace of 9.5 percent in July, matching June's rate, the fastest since September 1994. The bank warned that further rate rises will probably be needed to bring annual inflation to its target rate of 3 percent. It should also be noted that real interest rates in Chile are still negative - minus 1.75% - when compared with the current rate of inflation. Core inflation - ie the CPI less fresh fruit, vegetables and energy - was running at 9% in July, which is quite high, and even in relation to core inflation real interest rates are still negative.

Last month's inflation was faster than expected, the central bank said in today's statement. International ``inflationary pressures'' remain even as prices for oil and other commodities have fallen, the bank said.

``Given the deterioration in the inflationary outlook, this rise in the policy rate is necessary to ensure that inflation converges toward 3 percent'' during the bank's two-year policy horizon, it said in the statement. ``In the most likely scenario, further adjustments will be necessary to ensure that inflation converges with the target.''

Chilean economists increased their forecasts for 2008 inflation to 8.0 percent in the August central bank survey - up from the 7.5 percent regisetered in July's survey. They left their forecast for next year's price rises unchanged at 4.5 percent.

Last month's core inflation - which excludes fuel and perishable food - was the fastest since the National Statistics Institute started tracking it in January 1997 as housing, health care and transportation became more expensive. The cost of long- distance bus tickets rose 12 percent. Food climbed 18 percent in the 12 months through July.

Chile's Monetary Policy Group - an independent team of five academics that monitors the central bank's policies - unanimously called on Aug. 12 for the bank to raise rates by half a percentage point and end efforts to weaken the currency. The central bank has been purchasing $50 million a day since April to build reserves and stem gains in the peso - but the academics warned that the weakening of the peso could spur further inflation, on the other hand if they sterilise the purchases (ie reduce the money supply accordingly, then this can be a way to avoid excess liquidity arriving in Chile in the search for extra yield as Chile raises interest rates.

The peso has fallen 16 percent since the central bank announced the dollar purchases April 10.

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