Itaú BBA - COLOMBIA – Monetary Policy Meeting: Low policy rate level inspires caution over future moves

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COLOMBIA – Monetary Policy Meeting: Low policy rate level inspires caution over future moves

July 31, 2020

As we approach the end of the cycle, future moves would be dependent on how the recovery and inflation unfold

As expected, the board of the central bank of Colombia voted to cut the policy rate by 25bps, for the second consecutive time, to 2.25%, the lowest nominal rate since the bank’s independence. The decision had the full support of the board, following two split decisions, and takes the total easing cycle to 200 basis points. A short communiqué holds a neutral tone and, during the press conference, General Manager Echavarria suggested that the door to additional rate cuts remains open, but future decisions are set to be more data-dependent as the board evaluates the recovery progress.

The activity contraction is expected to be deeper this year, further reducing inflationary pressures. The technical staff downgraded its growth outlook for this year to a contraction between 10% and 6% (from a 2%-7% fall, previously). Growth would be hampered by weak global activity and the prolonged lockdown (recently extended to the end of August), that led to a significant labor market loosening. The negative output gap is expected to widen this year (to -7% / -5%) and start to narrow in 1Q21. With domestic demand slumping, Echavarria indicated that the technical staff also lowered the inflation forecast range to 1%-2% this year (1%-3% expected in 1Q20), below the 3% target. Echavarria noted that the central bank would closely monitor the activity recovery in 2H20 as well as how effective policy transmission to the credit market unfolds.

Some board members prefer caution going forward given the possibility of capital flight, while a negative real interest rate is not a restriction for Echavarría. We note the ex-ante one-year real rate, using the one-year inflation expectation from the July survey, is mildly negative. Hence, downward revisions to inflation expectations could provide additional incentive for lower rates. Overall, lower rates appear possible, but timing and magnitude of additional easing is more uncertain. Additionally, Echavarría reiterated the real neutral interest rate is still estimated at 1.4%.

On the liquidity measures, the board reinforced efforts to guarantee the smooth functioning of the financial system. To ease dollar liquidity tightening, the board will continue to roll-over expiring NDFs (approximately USD 3.0 billion). 

We expect the easing cycle to end with the policy rate at 2%. As we approach the end of the cycle, future moves would be dependent on how the recovery process and inflation unfold. Besides policy rate moves, the central bank may also act with further quantitative measures.

 

Miguel Ricaurte
Carolina Monzón



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