COLOMBIA – Monetary Policy Report: Swifter recovery supports higher rates

A partial normalization is the preferred route amid elevated levels of uncertainty

Vittorio Peretti & Carolina Monzón


The central bank’s quarterly monetary policy report outlines a swifter activity recovery than previously forecasted, narrowing the output gap and justifying less monetary stimulus. Under the updated forecast scenario, the central bank’s technical staff believes the appropriate policy rate trajectory would be somewhat above the expectations from the July analyst survey (rates at 2.0% in December 2021; 2.5% in March, and 3.5% by the end of next year). Undertaking a partial normalization is the preferred route as the staff foresees that spare economic capacity would prevail until 2023 amid elevated levels of uncertainty. 

Activity forecasts were revised to the upside on the back of reduced mobility restrictions, advancement on the vaccination front and a benign external outlook. For this year, the growth forecast was revised from 6.0% in April to 7.5% (Itaú: 6.5%), while a milder uptick of 0.1pp to 3.1% is envisioned for 2022. High terms-of-trade, still favorable global financing conditions and rising remittances would support dynamic domestic demand. Given the improved activity, the estimate of the negative output gap was reduced by 0.5pp to -2.3%. The development is coherent with General Manager Villar’s comments at last week’s press conference indicating that the space to maintain the current magnitude of monetary stimulus is narrowing. The increased domestic demand forecast would result in a wider CAD for this year (+0.7pp to 4.5% of GDP; 3.4% in 2020). The growth forecasts, which is surrounded by unusually high uncertainty, assumes that there will be no further social unrest and that possible new waves of Covid-19 contagion will not have additional negative effects on economic activity.

Inflation is seen ending the year above the upper bound of the range around the 3% target, but core inflation is more controlled. Yearend inflation was revised up by 1pp to 4.1% (Itaú: 3.7%; 1.6% last year). However, core inflation is expected to remain under control, at 2.6% this year (+30bps from April´s outlook). The joint behavior of core prices, together with continuous upward surprises in economic activity, are interpreted by the technical team as signs of still large excesses of productive capacity of the economy. This would persist for the next two years. For 2022 headline inflation is seen at 3.1%, while the core component is expected to sit close to the 3.0% target as the transitory supply shocks unwind by the middle of next year. 

We expect the central bank to start hiking rates, by 25bps, at its next meeting in September.   

Vittorio Peretti 
Carolina Monzón