Itaú BBA - COLOMBIA – Monetary Policy Report: Improved outlook, but rates likely to stay low

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COLOMBIA – Monetary Policy Report: Improved outlook, but rates likely to stay low

November 4, 2020

The average policy rate would be marginally higher than the October median analyst expectations

The central bank’s technical staff expects a somewhat milder GDP contraction this year, and a swifter rise in inflation. Nevertheless, the significant negative output gap and still-below target inflation supports a stance of stable rates for some time. In last week’s meeting, the board of the central bank held the policy rate steady at 1.75%, the first interruption to an easing cycle initiated in March and that extended 250bps. Going forward, the technical staff believes the baseline scenario supports a trajectory for the policy rate that is on average marginally higher than the median analyst expectation as of October (stable rates at 1.75% until 4Q21, thereafter-reaching 3.25% in two years). We believe this implies low rates for long, before a gradual normalization cycle.
The activity outlook is to some extent less bleak. Activity is now seen shrinking between 6.5% and 9.0% this year, with a 7.6% decline the most likely result. The previous quarter’s report pointed to a contraction of 6%-10%, with an 8.5% drop the baseline scenario. For 2021, the research team sees activity growing 4.6%, improving from 4.1%, previously. The potential reintroduction of additional lockdowns were not considered in the updated scenarios. Meanwhile, the improved outlook is based on a gradual recovery of private consumption and investment. Yet, activity is seen returning to pre-pandemic levels only towards the end of 2022, as internal demand is expected to recover slowly and terms-of-trade are seen below those recorded in recent years.
Inflation is seen ending the year at 1.9% (forecast range of 1.3%-2.3%), close to the lower bound of the range around the central bank’s 3% target. The outlook was upwardly revised from the 1%-2% range, with a point estimate of 1.5%, outlined in the previous report. For 2021, the yearend outlook also ticked up 30bps to 2.6%, while the forecast range remained at 2%-3%. Significant depreciation of the Colombian peso plays a role in the higher inflation. Nevertheless, the negative output gap would keep core inflationary pressures under control at 1.5% for this year and 2.5% next year. The low base of comparison would aid the convergence process to the 3% target.
The shock to domestic demand would support a narrowing of external imbalances this year. The current account deficit is seen at 3.4% of GDP this year, compared to the 3.7% envisioned previously (4.3% last year). Falling imports amid the weakened currency, receding internal demand and a lower income deficit (on the back of weak oil prices) would drive the result. For 2021, the CAD is expected to widen to 3.7% as activity recovers, and the profitability of foreign companies operating in Colombia increases. Meanwhile, favorable financing is still expected through FDI amid an external scenario of low-interest rates and abundant global liquidity.
Overall, the technical staff’s baseline scenario for key macroeconomic variables is broadly consistent with our expectations. Under such a scenario, we see stable rates at 1.75% until late next year, as the board will likely prefer to evaluate how the economy responds to the stimulus in place as the economy reopening consolidates. If the activity recovery underwhelms and inflation expectations retreat, possibly due to the onset of a second wave of the pandemic, a deeper easing cycle cannot be ruled out. The next monetary policy decision will take place on November 27.

Miguel Ricaurte
Carolina Monzón

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