In central bank parlance the battle between “macro-precautionary” or “macroprudential” measures (such as capital controls and higher bank reserve-requirements) and more traditional interest rate tools may yet favor the old school.  Barclays noted this week that at least “some EM policymakers appear to be waving the white flag in the currency wars” and as the FT’s beyondbrics noted today there’s no better example of such capitulation than Chile.  There the peso just set a new high, since April 2008, versus the dollar, while inflation is expected to stay above the central bank’s 3 percent target “for some time”.  The quandary of course is that rate hikes not only carry an economic cost but also attract “footloose foreign capital”–one primary reason why Brazil has attempted alternative measures.  The Economist noted that one solution however may be to “welcome the inflows, let [currencies] rise where [they] will and . . . eliminate expansionary fiscal deficits”–both of which would theoretically ease price pressures and permit monetary easing–in kind tempering inflows.  In Chile analysts expect another 50 point rise in May followed by consecutive 25 point hikes in June and July–leaving the key interest rate at 5.5 percent.  At the same time, however, aggressive primary spending as a % of GDP is not helping the cause: while high copper prices turned a structural deficit into a 0.4% surplus last year, for instance, the number appreciably lagged the pre-crisis 8.8% level.  In truth, this kind of stimulus should be saved until copper prices eventually do correct.  For now, and likely through 2012 the state of the copper market is such that further peso appreciation beyond 450 may be inevitable as current account surpluses get fat–regardless of whether that means intervention selling or capital controls come back in vogue.  Specifically analysts highlight that “miners are facing extreme challenges to growing output, including lower ore head grades, skilled labour shortages, equipment failures and long waiting times for new parts, all of which mean that mine supply will struggle to grow this year and is even in danger of contracting.”  When this supply dynamic reverses, however, is when Chile’s central bank will really be put to the test.

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