The Central Bank of Colombia has now raised its rate by a total of 75 basis points this year following a hike in September when it said the risk of an "unanchoring of inflation expectations has risen" along with the risk of a lasting increase in inflation.
In a statement from Oct. 30, the board of the central bank "reiterated its commitment to the inflation target."
The central bank targets inflation of 3.0 percent, plus/minus 1 percentage point, and inflation in September accelerated to a six-year high of 5.35 percent from 4.74 percent in August as the depreciation of the peso was passed through to consumer prices along with the impact of lower food supply from dry weather.
As a result, inflationary expectations for one to two years ahead rose to 4.1 and 3.5 percent while the yields of public bonds from two to five years topped 4.0 percent, the bank said.
In addition to the rate hike, the central bank also launched a call options mechanism to help ease what it described a "unjustified increases in the exchange rate, which may contribute to unanchored inflation expectations, as well as providing liquidity to the exchange rate market whenever a significant lack of it takes place."
An auction with one-month options worth US$500 million will be opened in the event that the exchange rate of the peso rises 7 percentage points above its 20-day moving average, the bank said.
The peso started depreciating in July 2014 in response to declining crude oil prices but it has been appreciating since late August when it reached almost 3,239 to the U.S. dollar. Today the peso was trading just under 2,899, still down 18 percent this year.
Meanwhile, Colombia's economy is improving, with the bank's staff revising upward their 2015 growth forecast to 3.0 percent from 2.8 percent, within a range of 2.4-3.4 percent.
The country's Gross Domestic Product expanded 0.6 percent in the second quarter from the first for annual growth of 3.0 percent, up from 2.8 percent in the first quarter, and the central bank said data for the third quarter "suggest a greater-than-expected dynamism.
The Central Bank of Colombia issued the following statement:
"The Board of Directors of Banco de la República at today’s meeting decided to increase the benchmark interest rate by 50 bp to 5.25%. For this decision, the Board mainly took into consideration the following aspects:
- Annual consumer inflation in September stood at 5.35%, and the average of the four measures of core inflation registered 4.89%. Analysts’ inflation expectations to one and two years increased, registering 4.1% and 3.5%, respectively, while those embedded in public debt bonds to 2, 3, and 5 years are above 4.0%.
- Acceleration of inflation so far this year is mainly explained by the pass-through of nominal depreciation to consumer prices and the increase in the cost of imported raw materials, as well as by the lower dynamics in food supply.
- Pass-through of part of the devaluation of the peso to consumer prices and a strong presence of El Niño have slowed down convergence of inflation to the target, due to its direct impact on prices and inflation expectations, as well as to the probable triggering of indexation mechanisms.
- The technical staff revised upwards its forecast of the most likely figure of growth for the economy in 2015 from 2.8% to 3.0%, within a range between 2.4% and 3.4%. New records of economic activity for the third quarter suggest a greater-than-expected dynamism. On the side of demand, retail sales show that household spending would have been more dynamic, in spite of the decline in the confidence index. Investment expectations show that construction and civil works would continue with good dynamics. On the supply side, the indicators for industry, retail trade and construction have performed better than expected.
- The increase in inflation expectations has considerably reduced the measures of the real policy interest rate and of the financial system. At the same time, domestic credit growth remains above the expansion of output.
- Figures for global economic activity continue to reflect a weak dynamics of external demand, below that recorded for 2014. The economy of the United States exhibited moderation in its growth rate, while the euro zone is recovering slowly. China continues slowing down, and the major Latin American economies exhibit low growth rates or output contractions.
- In the United States, the FED decided to maintain its benchmark interest rate unaltered. As for Latin America, the risk premia of the major economies remain at levels higher than those of 2014.
- The international prices of oil and other commodities exported by Colombia continue at low levels. The fall in the terms of trade recorded throughout the year has deteriorated national income, largely explaining the higher level of the exchange rate vis-à-vis the US dollar.
In short, inflation expectations have increased and the risk of a slowdown in domestic demand, beyond that which is consistent with the decline registered in national income, has moderated. In order to ensure convergence of inflation to the target range, the Board of Directors decided to increase the benchmark interest rate by 50 bp.
The Board reiterates its commitment to the inflation target and continues to carefully monitor the behavior and projections of economic activity and inflation, as well as that of asset markets and the international situation.
Finally, the Board announced a call options auction mechanism with the purpose of moderating unjustified increases in the exchange rate, which may contribute to unanchor inflation expectations, as well as providing liquidity to the exchange rate market whenever a significant lack of it takes place. The auction will be summoned for USD 500 million once the exchange rate reaches 7 percentage points above its 20 period moving average. Options will be valid for one month from the day of the auction and its exercise is subject to compliance of the aforesaid condition. "