The Central Bank of Colombia raised its policy rate by another 25 basis points to 6.25 percent and has now raised it by 175 points since embarking on a tightening cycle in September 2015 to push down inflation to its target of 3.0 percent, plus/minus 1 percentage point.
The central bank said pressure on inflation remains to the upside from higher-than-expected food prices and the fall in the peso's exchange rate from the fall in oil prices.
"Inflation expectations remain high and an additional pass-through of the devaluation of the peso to domestic prices is foreseeable," the bank said, signaling that it is likely to raise rates further.
However, the central bank also said that cuts in public spending and the firm commitment of the government to submit a structural tax reform this year would help ease the current account deficit and inflationary pressures.
Earlier today Colombia's finance minister said the government would cut 6 trillion pesos from its spending in response to the decline in oil-related revenue with the aim of reducing the deficit to 3.6 percent.
Standard & Poor's this week lowered its credit rating outlook on Colombia to negative, citing the current account deficit, which was 3.3 percent of Gross Domestic Product in 2014 and estimated to have risen to 6 percent.
Colombia's inflation rate jumped to a higher-than-expected 7.45 percent in January with expectations one to two-years ahead at 4.5 and 3.7 percent, respectively.
Although the central bank considers the rise in food prices and the depreciation of the peso as temporary shocks, it said the magnitude of the depreciation and the intensity of the El Nino weather patterns had raised the risk that inflation would be slower to converge to its inflation target as it would impact expectation and trigger higher prices through index mechanisms.
The peso has been falling since mid-2014, when crude oil prices started to decline, and fell by 25 percent against the U.S. dollar in 2015. Today it was trading at 3,355.6 to the dollar, down 5.4 percent since the start of this year.
Colombia's economy expanded by an annual rate of 3.2 percent in the third quarter of last year and the central bank said growth in the fourth quarter was similar to the third quarter, with growth for the full year seen at 3.0 percent, the same growth rate as the central bank estimated in January.
For this year, the central bank confirmed its forecast for 2.7 percent growth - within a range of 1.5 to 3.2 percent.
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 25 bp to 6.25%. For this decision, the Board mainly took into account the following aspects:
- Annual consumer inflation in January stood at 7.45%, and the average of core inflation indicators posted at 5.73%, surpassing the forecasts of the technical staff at the Central Bank. The measures of inflation expectations remain high: those by analysts to one and two years registered 4.5% and 3.7%, respectively, while those embedded in public debt bonds to 2, 3, and 5 years are between 4.5% and 5.0%.
- The increase in food prices as well as the higher nominal depreciation and its partial pass-through to consumer prices explain the increase in inflation in January. Although they are considered temporary shocks, the magnitude of the depreciation of the peso and the intensity of El Niño increase the risk of a slower convergence of inflation to the target, due to its direct impact on prices and inflation expectations as well as by the probable triggering of indexation mechanisms.
- The price of oil is still volatile and remains below the forecasts for this year. Global risk aversion has increased. In this environment, the largest economies of Latin America recorded once more increases in their risk premia and their currencies depreciated vis-à-vis the US dollar.
- The most recent information on global economic activity suggests that in 2015 the average economic growth of Colombia's trading partners was weak, and the forecast for 2016 suggests that its recovery will be somewhat slower than expected.
- New declines in oil prices continue deteriorating the terms of trade and are reflected in a further fall of the national income and, especially, of public revenue. Given that part of this fall is long-lasting, a permanent adjustment of domestic spending in the economy is required, for which fiscal policy measures are the most effective instrument. In this sense, the announced cuts in public expenditure and the firm commitment of the Government to submit a structural tax reform in 2016 are necessary measures for the economy to adjust to the new income levels.
- The most recent figures of economic activity suggest that output growth in the fourth quarter of 2015 would have been similar to that recorded in the third quarter. The dynamism of consumption and investment would have been lower, but net exports would have contributed positively to growth. For all of 2015, economic growth is projected at 3.0% as the most likely figure, within a range between 2.8% and 3.2%.
- In January, the Consumer Confidence Index declined significantly, registering a historically low level. However, uncertainty about the persistence of this low level of the indicator and its impact on household spending is high. Other indicators of economic activity are compatible with the technical staff's growth forecast for 2016 (2.7% as the most likely figure, within a range between 1.5% and 3.2%).
In summary, higher-than-expected increases in food prices and further increases in the exchange rate, largely related to the fall in the price of oil, continue exerting upside inflationary pressures. Inflation expectations remain high and an additional pass-through of the devaluation of the peso to domestic prices is foreseeable.
The Board of Directors decided to continue with the path of 25 bp increases of the benchmark interest rate, and will be particularly attentive to the behavior of inflation and its expectations in order to ensure convergence of inflation to its target in 2017. At the same time, the cuts announced in public spending and the firm commitment of the National Government to submit a structural tax reform this year, contribute to reduce the current account deficit and inflationary pressures.
On the other hand, with the purpose of mitigating the impact of an overreaction of the exchange rate on inflation expectations and contributing to preserve the conditions of liquidity of the foreign exchange market, the Board decided to modify the percentage for the activation of the auction of options to decumulate international reserves and their exercise from 5.0% to 3.0%. The other conditions of the mechanism remained unaltered.
The Board reiterates its commitment to the inflation target and continues to carefully monitor the behavior and projections of economic activity and inflation in the country, as well as that of asset markets and the international situation."