Consumer prices rose by 2.1% m/m in October, above the market consensus
in a Reuters poll of 1.9% and close to our call of 2.0%. The ending of
tax cuts on white goods and currency depreciation were the main reasons
for the high inflation print, while food inflation was largely
unchanged.

Consumer price inflation reversed September’s downward surprise and
stood at 0.6% m/m inOctober. The BNP Paribas forecast looked for a 0.4%
m/m advance, while the consensusestimate stood at a slightly lower 0.3%
m/m. As a result, annual inflation accelerated to 1.9%y/y. The core
price reading stood at 0.5% m/m and its annual pace moved up to 2.1%
y/y, thusreturning to BCCh’s 2-4% tolerance range (Chart 1).

The policy rate remained unchanged as expected.

    As a result of the monthly increase the headline inflation rate
increased from 11.2% y/y in September to 11.9%. We expect the impact of
the TRY’s depreciation to put further upward pressure on the headline
inflation rate ahead such that it peaks slightly above 12% in November.
We then expect headline inflation to fall from December onwards due to
base effects. In addition, the government plans to skip its regular
tobacco tax hike in January which will support a fall in inflation in
the short term. So headline inflation is likely to decline slightly
below 9.5% in Q1 2018. However, in light of the recent depreciation of
the TRY we have revised up our end-2017 inflation forecast to 11.2%,
from 9.8% previously. Our end-2018 forecast at 8.8% is unchanged for
now.

    We think the October CPI print will likely downplay the deflation
concerns that had been spikedby September’s unusually low reading (-0.2%
m/m; see Chile: Rates to stay put despite inflationsurprise). While
inflation expectations for the next twelve months declined in reaction
to the lowprints, the 1y/1y expectation had shown no deviation from the
3% official target according to thesurvey of economists (see Chile: On
hold, but concerns about low inflation).

    The SARB delivered a dovish, but highly cautious, monetary policy
assessment.

    In light of recent inflation dynamics, we continue to expect BCCh to
keep the policy rateunchanged at next week’s monetary policy meeting
(scheduled to take place on Tuesday). Weactually expect no rate changes
this year and until Q2 2018. As the economy gathers steam,BCCh should
start thinking about tightening monetary policy. We forecast a gradual
ratenormalisation cycle to start around the middle of next year and
expect the policy rate to stand at3.50% by end-2018, up 100 bp from the
current 2.50% level.

    Heightened uncertainty around the exchange rate’s path, given global
anddomestic political risks and the possible impact of further
downgrades remain aconcern for the Bank. While inflation risks have
returned to more or less balanced,the currency’s vulnerability to
changes in sentiment still remains an upside riskto inflation. Inflation
and growth forecasts were revised downward as expected,possibly
supporting the one member still arguing for a rate cut.
Broad-baseddownside surprises in core inflation, a resilient rand
exchange rate, and downsiderisks to growth are more likely to lead to
future rate cuts, than hikes, as some inthe market still believe.

    Out of twelve CPI components, ten contributed positively to headline
inflation in October. Thelargest contributions came from the housing and
food components that together explained 60%of the headline monthly
advance. Housing prices were mainly lifted by electricity tariffs.
Theincrease in food prices happened across the board and was not driven
by any particularcomponent. In contrast to recent trends, tradable
inflation stood at 0.9% m/m, while nontradableprices advanced a more
modest 0.3% in October.

    Bottom line: Inflation trends are largely moving as we expected, but
the SARBwill need more evidence of the medium-term profile improving.
For this tohappen, we think weakness in wage and employment growth will
be the mostconvincing. But further positive inflation surprises will
also help. We still seemore than an even chance that the SARB cuts rates
in Q3 – possibly September(25bps) and again in November (25bps). Market
conditions will play a criticalrole in the timing in our view, given the
main concern centers on how theexchange rate reacts to exogenous events
going forward. That said, it wouldnow appear that the SARB has indeed
built in scope for a short-term inflationsurprise, despite pointing to
the contrary in the Q&A session.

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