Itaú BBA - COLOMBIA – Monetary Policy Report: Large output gap calls for significant monetary easing

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COLOMBIA – Monetary Policy Report: Large output gap calls for significant monetary easing

mayo 5, 2020

Given the deterioration of the economic outlook, another 50bps cut this month is likely

In the central bank’s updated its baseline scenario, activity could contract by up to 7% this year (+3.3% last year) and inflation could fall to 1% (3.8% in 2019), justifying the stance that significant monetary stimulus is necessary. To date, the board has lowered the policy rate by 100bps to 3.25%. Going forward, the technical team notes that the timing, magnitude, and the rate at which rate changes occur will be mainly determined by: the magnitude and persistence of the supply and demand shocks; the evolution of inflation expectations; local financial conditions and the transmission of the policy rate; and COP developments.

In an acknowledgment to the current state of uncertainty, the updated scenario of the central bank incorporates significant forecast ranges. The technical staff believes the activity contraction could be between 2.0% and 7.0% this year, while not providing an outlook for 2021. The central bank notes that the activity evolvement will depend on the duration of lockdown measures and its effect on the labor market. With activity having started the year favorably, the technical team sees growth of 2.0% in 1Q20, still a relevant slowdown given growth was hovering near 4% until February. The worst impact on activity is expected for 2Q20, with an annual contraction between 10% and 15%, dragged by commerce and services. Moreover, the staff highlighted the external environment (trade partners shrinking between 4% and 9% and the complex outlook oil) as additional factors that would impact the Colombian economy. Overall, the negative output gap is expected to widen drastically from being nearly closed prior to the shock to reach between 3.0% and 7.0% on average during 2020.

The implosion of domestic demand will result in a rapid disinflation process from 2Q20. Inflation is seen ending the year within a 1%-to-3% range. Previously inflation was seen at 3.1% for this year. The expected drop in prices for non-essential sectors (excluding food and health services) and the announcements of price controls for some goods would contain inflationary pressures this year, despite the significant depreciation of the Colombian peso. Additionally, core inflation is also seen falling as private consumption falters amid the lockdown measures. For 2021, headline inflation is expected to converge to the 3% target.

The shock to domestic demand would support a narrowing of external imbalances. The current account deficit is seen between 2% and 5% of GDP this year, compared to the 4.4% envisioned in January (4.3% last year). The research team expects the current account to evolve in similar way to the periods of the global financial crisis in 2008 and the 2015 oil shock, when a deteriorated external outlook and downbeat internal demand led to a CAD narrowing. Meanwhile, favorable financing is still expected through FDI, although hindered by lower profits, fewer projects and reduced mining dynamism amid the distressed oil market scenario. 

We expect additional monetary stimulus ahead. Meanwhile, the board will continue to utilize its other monetary policy tools to ensure no significant tightening of financial conditions that could exacerbate the effect of the current shocks on the Colombian economy. The next monetary policy decision will take place on June 29, but we note General Manager Echavarría did not rule a rate decision taking place at May’s board meeting, so another 50-bp rate cut this month is likely.


Miguel Ricaurte
Carolina Monzón


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