We highlight that the median estimate for CPI inflation in two years still stands at 3% according to the latest BCCh survey. It is worth noting that the central bank's targeting regime has enjoyed strong credibility. Indeed, in the past three and a half years two-year inflation expectations (according to the BCCh's monthly survey) only differed from the 3% target in ten instances. Additionally, market inflation expectations - gauged by the B/E inflation rates implied by nominal and real swap rates - remain generally benign, at close to or even below the central bank's 3% target. The 1y/1y inflation measure currently stands exactly at 3%, while 1y/2y expectations stand at a lower 2.7%. The exception is expectations for the next 12-months, when markets look for a temporary CPI inflation acceleration to
4.2%.

Considering the incipient concerns expressed in the minutes of the latest monetary policy meeting, any persistent additional deterioration in medium-term inflation expectations could prompt a speeding up of the tightening pace. We currently expect BCCh to hike the policy rate by 50bp next week and then to moderate the tightening pace to a monthly 25bp, but we will continue to monitor inflation expectations closely to evaluate whether that expected trajectory alters.

Eoin Treacy's view Chilean short-term interest rates bottomed in July 2009 at 0.5% and began to push back up from June this year to today's level at 1.5%. Even though rates are likely to rise to 2% from tomorrow, the absolute level is still low by historic standards. For example the 2003 trough was at 1.75%. This suggests that while conditions are on a tightening trajectory they remain highly accommodative.

The Chilean Peso continues to factor in the widening interest rate differential with the US Dollar and the markedly different performance of the respective economies. Having retraced most of the bear market decline, the Peso has been ranging between 18 and 20¢ for most of this year. It has strengthened sharply over the last month and is somewhat overbought in the short-term as it tests the upper side of the congestion area. A downward dynamic sustained for more than a day or two would now be required to reaffirm resistance in this area.

The stock market is probably where the effects of loose monetary policy are most evident with the Chilean Select 40 Index continuing to hit new highs. The Index is more than 25% weighted by electric utilities followed by forestry, supermarkets and banks. Codelco, Chile's national copper miner is not a listed company. The Index has surged over the last couple of months and is now testing the 4500 level having become overextended relative to the 200-day MA once more. This overextension is the third in the course of the 20-month uptrend. The last two have been resolved by ranging consolidations which allowed the mean level to catch up with prices and it appears to be only a matter of time before another reversionary process begins.

Monetary conditions remains highly accommodative but will eventually revert to a stiff headwind to the stock market as they continue to rise over the coming months and potentially years, so it may not be reasonable to expect the remarkable consistency of the medium-term uptrend to be sustained indefinitely. Nevertheless, the price action remains extremely impressively and the medium-term upside can continue to be given the benefit of the doubt in the absence of a sustained move below the 200-day MA.