Colombia: BanRep raises the policy interest rate at June meeting
June 22, 2016
At its 22 June monetary policy meeting, the seven-member board of the Central Bank (BanRep) raised the policy interest rate from 7.25% to 7.50%. The move was in line with market expectations. The Central Bank has been battling inflation, which has been steadily increasing since mid-2015 and reached a record high of 8.6% in June—more than twice the Central Bank’s 3.0% target. BanRep’s response has been to hike the policy rate by 300 basis points since last September.
Inflation has been increasing following the depreciation of the Colombian peso. The peso is closely linked to the price of hydrocarbons, which make up over half of Colombia’s exports and saw their value tumble after last year’s collapse in oil prices. In 2016, other factors have conflated to put upward pressure on prices. The El Niño weather phenomenon resulted in a dry winter, which impacted crop output and pushed up prices for food. Strikes by truck drivers may also have played a role in June’s particularly high inflation. Although the weather and the strikes represent transitory shocks to inflation, higher prices have triggered indexation mechanisms, such as those applied to certain wages or pensions, which adds momentum to inflation and suggests it could persist after the shocks are over.
BanRep is also monitoring the current account deficit carefully. A large current account deficit is unsustainable and increases a country’s susceptibility to external shocks, potentially leading to a balance of payments crisis. Colombia is a long way away from a balance of payments crisis, but the Central Bank is keen on bringing the current account deficit to more sustainable levels. The Bank has attempted to mitigate the threat posed by the external imbalance by tightening consumer demand, particular for foreign goods. Ben Ramsey, Economist at JPMorgan, points out that although the current account deficit eased slightly in Q1, BanRep would ideally like to see it decrease further:
“BanRep now views the current account as correcting gradually, and softened its tone vis-à-vis previous statements, stating that the lower CAD “reduces vulnerability” to external shocks. In recognition of the Q1 CAD data, but clearly affirming the role of rate hikes in adjusting the current account, BanRep stated that monetary policy will “continue contributing to the correction” in the external deficit. In the post meeting press conference, Governor Uribe was more effusive, stating that by any measure the more pronounced-than-expected adjustment of the current account in 1Q was “an important signal” for the economy.”
Amid the sharp tightening cycle, concerns arose that BanRep may be overreacting to transitory pressures on inflation. Since much of the increase in prices was brought about by food shortages caused by inclement weather, it may seem logical that prices pressures would ease once the dry spell ended without intervention by BanRep. However, as Nelson Vera, Chief Economist at ANIF points out, the Central Bank’s tightening cycle is more than warranted:
“Clearly those who criticize Banrep for hiking rates in the face of unanchored inflation expectations don’t understand the Inflation Targeting Framework in which our Central Bank operates. The repo hikes that Banrep has been enacting are more than warranted, seeing that inflation has not only surpassed the 8.6% mark in June, but that inflation expectations for end 2016 are in the range 6-6.5% and near to 4% even at the end of 2017. We must be careful not to fallow Brazils footsteps, thinking that lower aggregate demand, FX pass-through or temporary climate factors will bypass the need for the central Bank to act (we all know the results in Brazil: 4% GDP contractions coupled with 10% inflation)”
Finance Minister Mauricio Cárdenas, who sits on the Bank’s Board of Directors, suggested after the meeting that the tightening cycle could be over. However, language in BanRep’s accompanying statement plainly left open the possibility for another rate hike. BanRep has claimed that its actions are data dependent, and, if inflation continues to increase, additional action by the Bank could be in store. The next meeting is scheduled for 29 July.
Author: Robert Hill, Economist