Forex Investment and Currency Trading

The FX reserve accumulation program announced on April 10th has helped curb CLP strength, but may be counteracting the impact of a more restrictive monetary policy (the Central Bank of Chile (BCC) has tightened 175bp in the last year). Since the program was announced, USD/CLP has climbed 16% to 501, assuaging exporters’ fears that a stronger CLP could hurt growth. However, CLP weakness is likely to contribute to an increase in tradable inflation which tends to lag changes in the FX rate.

At the beginning of the year tradable inflation (which accounts for 47.5% of CPI) was 8.1% yoy, but edged down to 5.6% in April as CLP appreciated 13% in the first few months of the year. This decline in tradable inflation otherwise reached double digits. Following the Central Bank of Chile’s FX intervention, tradable inflation jumped 1.9% mom (the highest monthly change in over eight years)
contributing an extra 0.4pp to headline annual inflation. The inflationary effects of a weaker CLP are relatively small for now, but with inflation of 8.9% (twice as high as the 2% to 4% target), BCC needs all the help it can get.

During the week of June 30th, BCC is set to announce the daily purchase amount of USD for the July-August period. Since the inception of the program on April 10th, BCC has purchased $50mn a day, accumulating $2.1bn in additional reserves. Although the intervention framework allows for a
discretionary change in the daily USD purchase amount, market thinks this is unlikely for the time being. On June 17th, BCC President Jose de Gregorio commented that the bank’s USD purchases constituted a form of “insurance” for the economy and expressed an intent to continue with USD
purchases for the time being. While USD/CLP is likely to remain volatile, stagnant copper prices and continued market concern with high inflation levels could push USD/CLP higher. However, if the expected decline in annual inflation does not materialize in the second half of 2008 it is possible that BCC could reduce its USD purchases and allow for some CLP appreciation – a move that would signal an opportunity to reinstitute long CLP positions.