Colombia: Central Bank makes surprise 0.50% rate hike and FX intervention
October 30, 2015
In a divided decision, the members of the Central Bank (BanRep) Board decided to increase the reference interest rate by 50 basis points from 4.75% to 5.25% at the Bank’s 30 October monetary policy meeting. The decision surprised markets, which had expected a softer 0.25% increase. In a context of weak growth, the decision signals that BanRep is strongly committed to its inflation target of 3.0% plus/minus 1.0%. This is the second consecutive time the Central Bank has hiked the reference rate. The next policy meeting is scheduled for 27 November.
In its accompanying statement, BanRep reaffirmed that recent data pointed to weaker external demand than in 2014. Growth in the United States has been moderate and the Eurozone is experiencing a modest recovery. In addition, the pace of China’s economy is continuing to slow and growth in Latin American countries remains subdued or even negative. BanRep highlighted that, “in the United States, the FED decided to maintain its benchmark interest rate unaltered. As for Latin America, the risk premia of the major economies remain at levels higher than those of 2014.”
Regarding the domestic economy, BanRep noted that the latest data point to better-than-expected growth in Q3, and revised its GDP forecast for 2015 upward from 2.8% to 3.0%.
In terms of price developments, BanRep pointed out that inflation in September and the average of four different measures of core inflation remained high and above its target. In addition, various indicators signal that medium-term inflation expectations are in the top range of the target or even above it. The main factors that are influencing these renewed inflationary pressures are nominal depreciation being passed to consumers, the increase in the cost of imported raw materials and a soft food supply. BanRep added that, “pass-through of part of the devaluation of the peso to consumer prices and a strong presence of El Niño have slowed down convergence of inflation to the target, due to its direct impact on prices and inflation expectations, as well as to the probable triggering of indexation mechanisms.”
Against this backdrop, the Bank decided to hike the reference rate for the second consecutive time. BanRep argued that, “inflation expectations have increased and the risk of a slowdown in domestic demand, beyond that which is consistent with the decline registered in national income, has moderated.”
Finally, BanRep announced that it will intervene in foreign exchange markets in order to stabilize the currency, which has been strongly depreciating since the second half of May 2015. The Central Bank detailed that it would implement, “a call options auction mechanism with the purpose of moderating unjustified increases in the exchange rate, which may contribute to unanchor inflation expectations, as well as providing liquidity to the exchange rate market whenever a significant lack of it takes place. The auction will be summoned for USD 500 million once the exchange rate reaches 7 percentage points above its 20 period moving average. Options will be valid for one month from the day of the auction and its exercise is subject to compliance of the aforesaid condition.” Regarding the impact of such a measure, Mario Castro, LatAm Strategist at Nomura, comments:
“We believe that this announcement has more symbolic than practical value for now. BanRep seems to be signaling that it is ready to begin to step into the FX market if needed to keep inflation expectations under control. However, we do not see significant practical implications for COP dynamics since the current intervention conditions look stringent (the conditions would have been met on only seven days since COP began its depreciation trend in June 2014).”
Author: Eric Denis , Economist