Itaú BBA - COLOMBIA – Monetary Policy Meeting: No signal of a rate cut (yet)

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COLOMBIA – Monetary Policy Meeting: No signal of a rate cut (yet)

julio 26, 2019

Confirmation of weaker-than-expected activity and a the looser global monetary stance needed before lowering rates

As expected, the board of the central bank of Colombia voted to keep rates steady at 4.25%. It was a unanimous decision to extend the period of stable rates to fifteen months and the press release announcing the decision was mostly unchanged from June. Meanwhile, rate cuts were not discussed, with general manager Echavarría highlighting the recent surge of headline inflation, even though due to supply shocks, as a key deterrent. Overall, the board is in wait-and-see mode, expecting activity dynamism to improve ahead which would narrow the output gap, while uncomfortable lowering rates amid rising headline inflation.

For the second consecutive month, the communication did not refer to the current level of the policy rate as “slightly expansionary”, a description utilized throughout most of this stability period. However, when asked about this during the press conference, Echavarría reaffirmed the slightly expansionary take on rates in Colombia. We note that not including the evaluation in the communiqué could reflect a lack of consensus in the board around the estimated real neutral rate in the context of lower global rates.

Weaker global growth was highlighted by the central bank. Meanwhile, the rising probability of a looser monetary policy in the United States would reduce pressures on the Colombia peso. 

Gradual narrowing of the negative output gap (by close to 1pp of GDP) is expected this year. In 2Q19, the central bank sees a growth recovery from 1Q19 (2.8%) led by consumption and investment (in machinery and equipment) dynamism. Meanwhile, the loosening labor market remains worrisome, with the central bank questioning what is driving the dynamics (immigration etc.).

The board highlighted controlled core inflation (near the 3% target) and emphasized supply-side shocks to food prices as the main reason behind rising headline inflation (3.4% as of June; 3.2% in 2018). The board expects higher inflation in coming months before a retreat towards the target thereafter.

The reserve accumulation scheme remains suspended. In May, the board interrupted the auction of FX put options in order to evaluate the impact on the exchange rate. During the time the program was active, the central bank purchased USD 2.8 billion (including purchases of dollars from the Treasury) leading to USD 52.4 billion (17.5% of GDP). The board could accumulate more reserves ahead, as stated by co-director Ocampo recently that Colombia’s biggest vulnerabilities are external and the current level of reserves (regardless of the IMF’s flexible credit line) are inadequate.

The board will likely remain in wait-and-see mode in the short term as headline inflation ticks up (to around 3.6%) before reaching 3.4% by yearend, amid controlled core inflation. Hence, we believe that the board would need to see confirmation of weaker-than-expected activity and for the looser global monetary stance to consolidate before lowering rates. The next central bank meeting will be held on September 27. We expect an easing cycle to start only by the end of this year, bringing the policy rate to 3.5% by 1H20.

Miguel Ricaurte
Carolina Monzón


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