The Chilean central bank’s plan to boost its depleted foreign currency reserves by 25% has roiled the peso and thrown an extra element of uncertainty into monetary policy.
(Bloomberg) — The Chilean central bank’s plan to boost its depleted foreign currency reserves by 25% has roiled the peso and thrown an extra element of uncertainty into monetary policy.
After falling by the most in the world on Monday following the announcement, the peso swung between gains and losses on Tuesday. The monetary authority said late Friday that it intends to add $10 billion to its coffers starting June 13 through daily purchases of $40 million.
Chile’s international reserves are lagging peers after policymakers spent billions of dollars to defend the peso when it plunged to a record low last year. The central bank’s foreign currency holdings stand at 11.5% of gross domestic product, down from a high of 18.6% in 2021. In monetary terms, reserves are now at the same level as they were in 2012.
“Chile’s reserve levels are low compared to Colombia, Mexico and Brazil,” said Sebastian Diaz, an economist at Pacifico Research in Santiago. “In that sense, Chile is somewhat vulnerable. It’s better to be prepared, and now is a good time to do so because the peso has strengthened a lot.”
The impact on monetary policy depends on the peso. A weaker currency could fuel inflation and delay an interest rate cut that most analysts expect in July. But the move to boost reserves could also demonstrate the bank’s confidence in the peso’s stability, indicating a borrowing cost reduction could be brought forward.
“The central bank will likely want to evaluate the impact of the announced program on the performance of the CLP before embarking on a cutting cycle,” Goldman Sachs Group Inc. economist Sergio Armella wrote in a note.
Read more: Chile Core Inflation Blocks Rate Cut Even as Economy Suffers
Economists surveyed by the bank expect monetary easing to start in July, with rates falling to 6.75% in a year from 11.25% now.
International Liquidity
The reserve-building program is aimed at strengthening Chile’s international liquidity position, according to the statement detailing the central bank’s plans.
The central bank will “sterilize” the program’s monetary effects through the issuance of promissory notes. In a separate document, the bank wrote that international reserves “act as insurance” against external shocks.
Read more: Chilean Peso Weakness Is a Sign of Central-Bank Confidence
Chile’s international reserve levels have remained below the International Monetary Fund’s recommended rate since 2017, according to data on the organization’s website.
The move is the second within a month to safeguard the economy against external shocks. In May, the bank announced a surprise decision to raise capital requirements on financial institutions, tightening credit conditions amid concern over global risks and the threat they could pose to the local economy.
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