Colombia: Central Bank continues with tightening cycle, makes eighth consecutive rate hike in April
April 29, 2016
At its 29 April monetary policy meeting, the Central Bank (BanRep) raised the policy interest rate from 6.50% to 7.00%. The intensity of the rate hike surprised analysts who had foreseen the Bank raising the rate by 25 basis points as opposed to 50. By accelerating its tightening cycle beyond market expectations, the Bank is aiming to combat heighted upside risks to inflation and inflation expectations. BanRep is also hoping that that rate hike will cool domestic demand, particularly demand for imported goods and services which will, in turn, reduce the country’s sizable current account deficit.
Despite the surprisingly-large hike, the Bank’s press release was largely unchanged from the previous meeting. BanRep highlighted upside risks to inflation, particularly stemming from the weakness of the currency, as well as from food shortages associated with the El Niño phenomena. Regarding global economic activity, the Bank commented that the Fed’s monetary policy tightening cycle was likely to be a more gradual process than previously expected. This, combined with a steady increase in oil prices from their record lows in February, has increased demand for the Colombian peso, which recovered some ground after falling to a five-month low in late April. Colombia is also facing external challenges that continue to present risks to growth. BanRep pointed out that Colombia’s trading partners were experiencing slower growth than had been expected, which will likely impair the Colombian economy’s exporting industries.
Regarding monetary policy, the Bank had previously opted for more gradual 25-basis-point increases between meetings. However, BanRep’s board of directors had been split on the pace of these rate hikes, with a dovish side backing a consistent 25-basis-point increase, and a hawkish side, which supported more drastic increases of 50 basis points. The hawks felt that larger rate hikes were a more effective method of combatting inflation and that they would shorten the time span of the tightening cycle. It appears that in the latest meeting the divide was in the more hawkish group’s favor. This leads some analysts, including Ben Ramsey, Economist at JPMorgan, to believe that the Bank could pause its tightening cycle at the next meeting. Ramsey comments:
“Looking back at the minutes from the March meeting, the […] minority camp that desired a 50bp hike then, argued not only that this would have ‘accelerated convergence of inflation expectations to the target’, but also would have ‘allowed to end the cycle of increases of the interest rate earlier’ (our emphasis). This suggests to us that BanRep’s bias is to pause after this meeting—if the data allows. […] All told, we are now tentatively expecting BanRep to pause until 4Q, at which point we continue to see space for an easing cycle in sympathy with receding headline inflation and sub-par growth.”
Dissenting views persist and not all analysts believe that BanRep will pause after its latest rate hike. This has much to do with underlying inflationary pressures, which appear to be steady. Inflation was lower than expected in April. Although this is a welcoming development, the data indicates that the inflationary pressures that the Bank is concerned about still persist. For example, the lower-than-expected inflation was due in part to lower electricity prices in April, which occurred after the government had cut regulated electricity tariffs. Prices for food and core inflation continued to show strong increases.
The apparent persistence of inflationary pressures has led Mario Castro, Research Analyst at Nomura, to expect continued rate hikes from BanRep. Regarding the lower than expected inflation, Castro stated that:
“As is usual after an inflationary surprise, the key question now relates to the likely monetary policy implications. We do not expect yesterday’s surprise to have implications for our expected path for the monetary policy rate. In particular, we continue to expect BanRep to hike to 7.50% in the coming months and to remain on hold throughout the rest of 2016.”
Lastly, BanRep still sees the excessive current account deficit as problematic, and a symptom of, “excessive expenditure over national income, and in which the risk of an excessive deceleration of domestic demand continues to be moderated”. With its latest rate hike, the Bank is hoping to cool domestic demand, which is expected to curb inflation, as well as reduce Colombia’s appetite for imported goods. The next policy meeting is scheduled for 27 May.