In addition, despite a promising domestic growth scenario, the Chilean economy remains operating below full capacity with above normal unemployment levels. This limits inflationary pressures, which is consistent with maintaining a highly and exceptionally expansionary monetary policy (figure 1). On the other hand, financial stress in Europe is raising the level of uncertainty regarding the speed with which the world economy will recover and the smooth functioning of global financial markets. Although the baseline scenario in the two reports we are presenting today assumes that both the world economy and the Chilean economy will keep growing in the coming quarters, the international situation, particularly in Europe, together with its impact on our economy and its implications for monetary policy will have to be assessed carefully and continually. All these elements, which are taken into account in every monthly monetary policy meeting, determined that in yesterday’s meeting we began the process of normalizing the significant monetary stimulus currently in place in Chile. This is the natural step after the gradual withdrawal of the extraordinary facilities for liquidity provision and the term liquidity facility FLAP, implemented in recent years to deal with the severe effects of the crisis of 2008–2009. In the current juncture, it is highly convenient to normalize the monetary stimulus. In the first place, because the current monetary policy instance was implemented in a context of significant economic weaknesses and strong disinflationary pressures observed in the first half of last year. As output gaps have begun to narrow, that dosage of stimulus is not necessary.

Annual inflation figures are somewhat below levels foreseen in March. This is because the immediate effects of the earthquake and tsunami, if any, were bounded and certainly smaller than projected in the last IPoM or by overall market expectations. Despite this difference, the assumptions about changes in some specific prices such as public transport fares, the tobacco excise tax or the unchanged stamp tax will result – in the baseline scenario – in inflation being at the end of 2010 in the upper area of the tolerance range of the inflation target. Towards 2011 and 2012, annual CPI inflation will oscillate around 3% and will stay there through the end of the relevant projection horizon, this time the second quarter of 2012. Core inflation will show a slower convergence to 3%, to hit that figure over the course of 2011. These projections are consistent with June’s Economic Expectations Survey, which foresees y-o-y inflation for December of this and next year at 3.5% and 3.2%, respectively, and at 3% two years ahead (figure 7). Aside from the assumptions just described for domestic and external growth, the baseline scenario considers that in the long run the real exchange rate (RER) will be similar to its current level. This, considering that, with the current level of the nominal exchange rate and the parities prevailing at the statistical closure of this IPoM, the RER is aligned with its longterm fundamentals. The domestic growth scenario foreseen for the coming quarters assumes output gaps closing fully during 2011.