Chile: Outlook improves but copper rally overdone – BBH

Analysts at BBH note that the Chilean peso has been on a tear, boosted by rising copper prices and think that the copper rally is overdone, but the growth outlook has improved while political uncertainty may pick up as November elections approach.

Key Quotes

“President Bachelet is in the final year of her second 4-year term.  Despite ending her first term (2006-2010) with record high approval ratings, Bachelet has struggled in her second term.  Sluggish growth is one factor, but so apparently is voter discontent with the status quo.”

“Her 32% approval rating in July is up from lows near 20% last year, but she is still fighting lame duck status.”

“After a protracted slowdown, the economy is finally picking up.  GDP growth is forecast by the IMF to accelerate modestly to 1.7% in 2017 from 1.6% in 2016, before picking up to 2.3% in 2018.  GDP rose 0.9% y/y in Q2, the strongest rate since Q3 2016.  Monthly data so far in Q3 suggest further improvement, so we see modest upside risks to the growth forecasts.”  

“Price pressures remain low, with CPI rising only 1.7% y/y in both June and July.  This is the lowest rate since October 2013, and is below the 2-4% target range.  However, PPI rose a cycle high 10% y/y in July and points to rising pipeline price pressures that warrant caution on the part of policymakers.  August CPI will be reported next Friday and is expected to accelerate to 1.9% y/y.”

“This supports the case for steady rates, and we believe the central bank will remain on hold for the time being.  The next policy meeting is September 14, and no change is expected then.  Indeed, the central bank signaled an end to the easing cycle after its last 25 bp cut to 2.5% back in May.”  

“Fiscal policy has deteriorated due to low copper prices.  The budget deficit came in at an estimated -3.0% of GDP in 2016, and it is expected to remain around -3% in both 2017 and 2018.  However, much will depend on copper prices.”  

“The peso has done well even after a strong 2016.  In 2016, CLP rose 5.5% vs. USD and was behind only the best performers BRL (22%), RUB (20%), ZAR (13%), and COP (6%).  So far in 2017, CLP is up 7% YTD and is amongst the top EM performers.  Ahead of it are MXN (16.5%), THB, (8%), and KRW (7%).  Our EM FX model shows the peso to have WEAK fundamentals, so this year’s outperformance is likely to ebb.”

“Earlier this week, USD/CLP had dropped to 623, the lowest since June 2015.  After a modest corrective bounce, the pair seems poised to test the May 2015 low near 593.  After that is the October 2014 low near 574.”

“Our own sovereign ratings model showed Chile’s implied rating falling a notch this quarter to BBB+/Baa1/BBB+.  The fall in copper prices has taken a toll and actual ratings of A+/Aa3/A are still facing downgrade risks.  Indeed, Fitch recently cut Chile one notch to A while Moody’s moved the outlook on its Aa3 rating from stable to negative.  This comes after S&P cut Chile one notch to A+ back in July.”