Itaú BBA - COLOMBIA – Monetary Policy Meeting Minutes: Board majority eyes inflation expectations

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COLOMBIA – Monetary Policy Meeting Minutes: Board majority eyes inflation expectations

December 22, 2020

The minority is concerned with the possibility of a wider-than-estimated negative output gap.

The minutes of the December monetary policy meeting to hold the policy rate at 1.75% unveil that a minority in the board (2 of 7) believe further easing is warranted amid lower-than-expected inflation that is possibly due to a larger negative output gap. Meanwhile, most board members point to anchored medium-term inflation expectations as an indication that the current expansionary stance is sufficient to ensure inflation convergence to the target. Although not our base case scenario, the division within the board, the upcoming changes to its composition, and the possibility of a return to strict lockdown measures amid a second coronavirus wave, mean we cannot rule out the implementation of additional rate cuts ahead.

Board members highlighted the lower-than-expected November inflation (1.49%), reasonably anchored medium-term inflation expectations, and an activity recovery that is progressing at a favorable pace despite the risks associated with the evolution of the pandemic and the fiscal front. Regarding the monetary policy response, the board reaffirmed its view that lower rates have been adequately transmitted to the market and external financial conditions remain favorable.

For the five-member majority, the central argument to keep rates stable at 1.75% was the need to focus on measurements of medium-term inflation expectations. This group recognized that, although the latest inflation records are low, recent declines and further drops expected in the short-term would begin to unwind during 2H21. Given that medium-term expectations remain close to the 3% target (2.7% for 2021 and 3.0% for 2022) and that the information available on economic activity points towards a swift recovery, most board members did not deem it necessary to increase the monetary impulse. Furthermore, the group was weary that frequent changes to the rate stance (in either direction) would signal policy instability to the market.

Meanwhile, concerns with the magnitude of the output gap led the call for additional easing. While the minority group within the board acknowledged that the recent low inflation prints had not been converted to falling inflation expectations, a potential fall of expectations would result in the policy stance becoming less expansionary. Moreover, a potentially larger negative output gap than previously envisioned would bolster the need for a further impulse to aid the economic recovery and ensure the convergence of inflation to the 3% target. Supporting their call is these co-directors’ belief that the risks that could limit the central bank's ability to reduce rates have diminished.

We expect rates to remain stable for a prolonged period at the historically low level of 1.75%. Our assumption considers a gradual activity recovery that will support inflation converging towards the 3% target during 2021. However, we cannot rule out additional rate cuts, particularly if activity recovery disappoints, amid more benign financial conditions and low current inflation.

Miguel Ricaurte
Carolina Monzón

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