Colombia: Colombian peso demonstrates heightened volatility, Central Bank scraps FX intervention program
June 8, 2016
The past 30 days have been volatile for the Colombian peso. It has been both pushed up and dragged down by a number of external and internal factors that have caused sizable swings in the peso’s value against the USD, making it more volatile than other Latin American currencies. In early May, the currency hit is strongest value since November last year amid a steady increase in oil prices. As May progressed, however, the peso began to lose ground and by May 30 it had fallen to its weakest value since mid-March 2016. The depreciation continued into the beginning of June. On 2 June, the peso softened to 3085.2 COP per USD, marking a sharp 8.9% monthly depreciation and a 20.7% annual depreciation. That said, the currency has recorded some slight gains on a year-to-date basis, appreciating 2.8%.
There are two major external factors that have impacted the peso in recent weeks: expectations regarding a potential increase in the U.S. federal funds rate and the rise in the price of oil. Minutes from the Fed’s April policy meeting were released on 18 May and revealed that the Fed was considering a rate hike as early as June. This information took emerging-market currencies by storm and the Colombian peso tumbled 4.4% on a monthly basis—the largest monthly decline since early February when oil prices fell to their lowest level in years. However, May’s dismal U.S. jobs report and the subsequent statement by Fed Chair Janet Yellen dashed expectations of a June rate hike. Shifting expectations regarding the Fed’s next rate hike, plus the steady increase in oil prices, boosted the peso in the first week of June.
Developments in Colombia have also contributed to the peso’s volatility, particularly the Central Bank’s foreign exchange intervention practices. In October last year, the Bank introduced a foreign exchange intervention mechanism which was designed to moderate, “unjustified increases in the exchange rate, which may contribute to unanchor inflation expectations.” This mechanism automatically triggered the sale of international reserves once the exchange rate depreciated beyond a certain threshold compared to its 20-day moving average. Although the threshold was lowered several times since the mechanism’s inception, the mechanism was only triggered once, in late May. On 27 May, the Central Bank announced that it would scrap the intervention mechanism, but did not give a clear explanation for doing so. The announcement prompted the peso’s exchange rate to deteriorate. For more insight into what drove the Bank to scrap the mechanism, Research Analyst Mario Castro at Nomura elaborates:
“We believe that one driver of the decision is BanRep’s understanding of how expensive and ineffective the use of international reserves is to counter-balance a depreciation pattern induced by global forces. The decision is also congruent with BanRep’s long-held stance to let COP adjust without interference to act as a key tool in reducing the current account deficit.”
The Bank stated that, although the mechanism was removed, it would still intervene in foreign exchange markets at its own discretion when it deems necessary.
Author: Robert Hill, Economist