It is the first policy easing by the Central Bank of Colombia this year but the second rate cut since December last year for total cuts of 50 basis points. In August 2016 the central bank paused in a tightening cycle after raising rates by 325 points to curb accelerating inflation.
The central bank said the rate cut reflected a weakening economy and the risks of excessive deceleration, uncertainty about how fast inflation would converge to the bank's 3.0 percent target and a real policy rate that is contractionary.
Four members of the central bank's board approved the rate cut while two members wanted to maintain the rate. Last month, when the central bank left its rate steady, four board members supported that decision.
Colombia's inflation rate decelerated for the sixth consecutive month in January to 5.47 percent from 5.75 percent in December while analysts' expectations to December 2017 rose and continue to remain above the 2-4 percent target range. But expectations as expressed in public bonds remained stable and between 3.7 percent and 4.8 percent for the next 2, 3 and 5 years.
Colombia's economy improved to growth of annual growth of 1.6 percent in the fourth quarter of last year for average 2016 growth of 2.0 percent, higher than the 1.8 percent that the central bank estimated in January.
But consumer confidence in January fell sharply and if this affects household spending, the growth forecast for this year may be lowered to 2.0 percent, within a range of 0.7 and 2.7 percent, the bank said. In January the central bank also forecast 2.0 percent growth this year.
The Central Bank of Colombia issued the following statement:
"The Board of Directors of Banco de la República at today’s meeting decided to reduce the benchmark interest rate by 25 bp to 7.25%. For this decision, the Board mainly took into account the following aspects:
- In January, annual consumer inflation decreased for sixth consecutive month, reaching 5.47%. The average of core inflation indicators remained stable at 5.61%. Analysts’ inflation expectations to December 2017 increased, and continue above the range of 2.0% to 4.0%; those to two years and those embedded in public debt bonds to 2, 3, and 5 years remained stable, posting between 3.7% and 4.8%.
- The effects of the strong transitory supply shocks that diverted inflation from its target continue to fade. For example, the slowdown of the food CPI in January suggests this.
- External demand growth is expected to be higher in 2017 than in 2016. The long-term international interest rates remain at levels higher than those recorded in 2016 and the Colombia’s terms of trade are still recovering. In this environment, the peso has appreciated vis-à-vis the US dollar.
- In Colombia, economic growth in the fourth quarter of 2016 was 1.6%, slightly better than in the third quarter; for the whole year it stood at 2.0%. The consumer confidence indicator for January 2017 recorded a sharp fall. Should this be reflected on household spending, the growth forecast for 2017 could be reduced (2.0% within a range between 0.7% and 2.7%).
- Considering the current level of core inflation indicators and inflation expectations, various calculations of the real policy interest rate are above its average since 2005.
Based on this information, the Board considered the following factors in its decision:
- The weakness of economic activity and the risk of an excessive deceleration.
- Uncertainty about the speed of convergence of inflation to its target.
- The current level of the real policy interest rate is contractionary.
In this environment, the Board considered that the path of policy interest rates compatible with an adequate balance of the aforementioned risks includes a 25 bp reduction. The new information on inflation, economic activity, and the international context will determine the pace of policy normalization.
The decision to reduce the benchmark interest rate was approved by four members of the Board. The remaining two Board Members voted in favor of keeping the benchmark interest rate at 7.5%."