May 27, 2016
At its 27 May monetary policy meeting, the seven-member board of the Central Bank (BanRep) raised the policy interest rate from 7.00% to 7.25%. The move was in line with market expectations and marked the ninth consecutive increase in the policy rate. The Central Bank indicated that it had hiked the policy rate in accordance with its goal of bringing inflation toward its long-term target of 3.0% plus/minus 1.0 percentage point. However, after the meeting, the Minister of Finance suggested that the current tightening cycle could be drawing to a close. Lastly, the Bank announced that it would scrap its automatic foreign exchange intervention program.
The Bank noted that although inflation eased in April, it had only done so via a transitory decrease in electricity prices and core inflation in fact increased. BanRep restated that although the El Niño phenomenon and the depreciation of the peso were temporary factors, they have had a lasting impact on inflation and inflation expectations, both of which have detached from the Bank’s 3.0% target. Regarding external developments, the Bank noted the salience of the Fed’s expected upcoming rate hike. Although it is unclear when the next policy rate hike will happen in the U.S the increase could take place earlier than had been expected, which would exacerbate pressure on the peso. However, a steady increase in the price of oil has brightened prospects for the Colombian peso, which is closely linked to energy prices.
Regarding the future interest rate path, BanRep’s accompanying statement did not offer much specific guidance. However, the Minister of Finance, Mauricio Cardenas, who holds a seat of the Bank’s board, stated that the tightening cycle is at, or nearly at, an end. BanRep has signaled that it is acting on a data-dependent basis and, given that core inflation is still inching upwards, there is the possibility of another rate hike before BanRep halts the hiking cycle. Ben Ramsey, Economist at JPMorgan, sees inflation peaking in July and expects that one more 25-basis-point increase is in store before the end of the tightening cycle. Ramsey stated:
“Although we see activity data softening and inflation—largely a phenomenon of supply shocks (FX passthrough and El Niño)—poised to fade sharply in 2H16, base effects can continue to lift the headline CPI by midyear—far from the 3% +/- 100bp target. Inflation expectations have drifted higher but not dramatically so; they are hovering near the top of the target range. But they could be tested by the headline drift expected in the May-July readings. All told, we think BanRep can hike 25bp once more in June to 7.5% to give itself a bit of insurance, but we still see room for an easing cycle by 4Q16. By then, supply shocks should clearly begin to drag down headline inflation (and with it, likely expectations) while more subdued domestic demand should be evidenced in the activity data.”
BanRep also announced that it would end its foreign exchange intervention mechanism, which was put in place in October of last year. The mechanism aimed to safeguard the peso from a drastic depreciation and automatically triggered the sale of foreign exchange reserves once the peso had weakened beyond a certain threshold. The decision suggests that the Bank thought that selling reserves had a limited impact on the value of the peso and that the need for such a mechanism had lessened as the peso has stabilized in recent weeks amid a steady increase in oil prices. However, the Bank left open the possibility of intervening in foreign exchange markets at its own discretion.