Itaú BBA - COLOMBIA – Monetary Policy Meeting: A cut before a pause

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COLOMBIA – Monetary Policy Meeting: A cut before a pause

August 31, 2020

The board is likely to evaluate how the economy progresses, while keeping the door ajar for further easing

In a widely anticipated move, the Central Bank board unanimously opted to cut the policy rate by a further 25-bps to 2.0%, extending the easing cycle to 225-bps. While the communique is low on insight, the tone from general manager Echavarria’s press conference signals that, while nothing can be ruled out, room for additional stimulus is narrowing, and decisions would be highly data-dependent. Overall, the messaging is consistent with a pause next month as the board evaluates how the economy progresses following the quarantine lifting, while keeping the door ajar for further easing.

The decision to cut rates further was justified by low inflation, a loosening labor market, a significant output gap, improving financing conditions and some external imbalance correction. Recent data was broadly in line with the technical staff’s expectations. The general manager acknowledged that under lockdown conditions, lower rates have not had a meaningful impact, but this is expected to change as the country rolls back strict sanitary measures from September on. This view is consistent with the expectation of a pause ahead as the board analyzes the economic response. In turn, we note that policy transmission to loan rates still has room to go.

There is less space for cuts going forward. Echavarria noted that rates are now at the lowest nominal level since the Bank's independence. We note the ex-ante real rate, using the one-year inflation expectation from the August survey, is mildly negative and at a similar level compared with the Financial Crisis in 2009. Additionally, Echavarria reiterated the technical staff’s baseline scenario of an 8.5% GDP contraction this year and inflation between 1% - 2% by the end of 2020, while also reinforcing that the staff expects policy rate to remain close to 2% for a prolonged period of time (outlined in the quarterly monetary policy report earlier this month). Further signals that the board is likely in no rush to react further is Echavarria’s comment that an important portfolio outflow has unfolded in recent months, while FDI is down some 20% from last year. Numerous board members have flagged capital flows as a key factor in their decision-making, in a context of wide current account deficit.

The board also communicated the rollover of dollar forward operations scheduled to expire between now and the next policy meeting in late September.

We expect the board to adopt a wait-and-see approach for the time being. While a significant output gap and low inflation favor calls for additional stimulus, the board will likely prefer to evaluate how the measures implemented to-date aid the economic response as the country reopens and how financial conditions behave. We see rates remaining at 2.0% throughout 2021, but we do not discard additional easing if the activity recovery underwhelms and risks to inflation (from potential capital outflows and its impact on the exchange rate) are contained.

Miguel Ricaurte
Carolina Monzón

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