Thursday, September 30, 2021

Colombia joins Mexico in raising rate to curb inflation

      Colombia's central bank joined its South American brethren, along with a growing number of central banks worldwide, and raised its main interest rate to prevent accelerating inflation from becoming entrenched through rising inflation expectations and thus a longer-term threat to financial stability.
      The Central Bank of Colombia (CBC) raised its benchmark interest rate by 25 basis points to 2.0 percent - its first rate hike since July 2016 - shortly after the Bank of Mexico (Banxico) raised its rate for the third time this year by 25 points to 4.75 percent.
      Illustrating the quickening pace of central bank rate hikes, the central banks of Jamaica and the Czech Republic also raised their rates today, boosting the number of banks that have raised their rates in September alone to 16, up from 14 in August and 10 in July.
      Colombia now joins other Latin American banks of Brazil, Chile, Peru, Mexico and Uruguay in trying to curb rising inflationary pressures as demand bounces back while supply chains remained strained and commodity prices are soaring.
      Colombia becomes the 31st central bank to raise its rates so far this year, including 11 emerging market central banks, as they unwind some of last year's extraordinary monetary stimulus that was aimed at cushioning economic activity during the COVID-19 pandemic
      The board of Colombia's central bank was split in its decision, which was widely expected, with 4 members voting for the 25-point hike and the other 3 voting for a 50-point rate hike.
     "A recovery in economic activity that was interrupted by roadblocks and a third wave of COVID-19 in the second quarter was restored in the third quarter," CBC said, raising its forecast for economic growth this year to 8.6 percent from July's forecast of 6.5 percent.
      For 2022 CBC forecast growth of 3.9 percent in 2022.
      Inflation in Colombia has been rising in the last four months and rose to 4.4 percent in August - well above CBC's 3.0 percent target - and the bank's staff raised its inflation forecast for this year due to domestic and external supply shocks, along with a faster expected closing of the output gap.
      The staff now expect inflation of 4.5 percent by the end of this year, up from last month's forecast of 4.1 percent, and forecast 3.5 percent inflation by the end of 2022.
      At the Bank of Mexico, 4 board members voted for today's rate hike while one member voted to maintain the rate.
      Although Mexico's inflation rate has trended lower since April, at 5.59 percent in August it remains above the bank's 3.0 percent target, and Banxico said inflation expectations for both this year and 2022 had risen.
      Banxico raised its forecast for headline inflation in the third quarter to 5.8 percent from last month's forecast of 5.6 percent and fourth quarter inflation to 6.2 percent from 5.7 percent.
     But it also expects inflation to trend down next year, ending the year at 3.4 percent and to ease in 2023.
     "Although the shocks that have increased inflation are expected to be transitory, due to their variety, magnitude, and the extended horizon over which they have affected it, they may pose risks to the price formation process and to inflation expectations," the bank said.
      The Central Bank of Colombia issued the following statement followed by the Bank of Mexico's press release about its policy decision:

"Banco de la República's board decides unanimously to begin normalizing monetary policy

The board voted 4-3 to raise the benchmark interest rate by 25 basis points to 2.0%; the three dissenting board members voted for a 50-basis point increase.

This decision was based on the following considerations:

  • A recovery in economic activity that was interrupted by roadblocks and a third wave of COVID-19 in the second quarter was restored in the third quarter. A strengthening of demand both domestically and among Colombia's major trade partners would be expected to encourage economic dynamism over the rest of the year, with GDP growth now projected at 8.6% in 2021 and 3.9% in 2022. The higher-than-expected forecasts suggest that excess productive capacity could be closed more quickly than previously anticipated.
  • Annual inflation continued on an upward trajectory in August, reaching 4.4%; core inflation (CPI excluding food and regulated items) reached 2.3%. The increase can be explained in large part by domestic and international supply shocks that are expected to be transitory but whose durations may vary. The partial reversion of some price relief measures, amid more dynamic demand and a reduction in excess capacity, would also be a factor.
  • The persistence of external shocks, indexation to higher inflation rates on some prices, and a faster-than-expected closure of the output gap have led the technical staff to revise its inflation forecasts upward to 4.5% for the end of 2021 and 3.5% for the end of 2022. Expected inflation has increased, though in the medium term remains close to the target. The increased persistence of supply shocks and their upward effects on prices could distance expectations from the target rate.
  • The more positive performance of demand relative to supply has been reflected in an increase in the current account deficit, which according to the technical staff's most recent estimates will reach 5.0% of GDP at the end of 2021, higher than the 3.6% deficit in 2020. This can be explained in large part by a greater trade imbalance on goods and services associated with a significant increase in imports compared to exports. Capital flows, including foreign investment, will provide the primary source of financing, underlining the importance of macroeconomic stability.
  • In reviewing the balance of risks the board of directors was cognizant of the significant amount of uncertainty surrounding these forecasts, as well as of the remaining risk of the COVID-19 pandemic once again worsening and affecting recovery in domestic and international demand. The board also recognized the risk of deviation in expected inflation compared to the target becoming a persistent phenomenon that could lead to indexation at higher rates of inflation.  "

The Bank of Mexico issued the following statement:

Banco de México’s Governing Board decided to increase the target for the overnight interbank interest rate by 25 basis points to 4.75%, effective October 1, 2021.

Global economic activity continued to recover, although at a slower pace and heterogeneously across countries, associated with vaccine availability, the evolution of the pandemic, and spending programs. Global inflation continued increasing due to pressures on commodity prices, base effects, bottlenecks in production, and to stimulus spending and its recomposition towards merchandise. The central banks of the main advanced economies have maintained the monetary accommodation, although some of them are already expecting to diminish it, while those of several emerging economies continue reducing it. Among key global risks are those associated with the pandemic, inflationary pressures, and adjustments in monetary and financial conditions.

In domestic financial markets, the volatility of the peso exchange rate and interest rates have increased. The recovery of the Mexican economy continued during the third quarter and is expected to endure for the rest of the year and 2022. Uncertainty about the pandemic persists and slack conditions are anticipated, with significant differences across sectors.

Global inflationary pressures and bottlenecks in production continue affecting headline and core inflation, which during the first fortnight of September registered annual variations of 5.87% and 4.92%, respectively. Headline and core inflation expectations for 2021 increased again, those for the next 12 months and for 2022 also rose, while those for longer terms have remained stable at levels above the target.

Headline and core inflation forecasts were revised upwards compared to those previously released (see table). Considering the nature of the shocks that have affected them, the larger increases correspond to the short term. Annual headline and core inflation projections are expected to decrease, particularly for one year and beyond, and to converge to the 3% target by the end of the forecast horizon. These forecasts are subject to risks. On the upside: i) external inflationary pressures; ii) cost-related pressures; iii) core inflation persistence; iv) exchange rate depreciation; and v) increases in agricultural and livestock product prices. On the downside: i) a widening of the negative output gap; ii) additional social distancing; and iii) exchange rate appreciation. The balance of risks for the trajectory of inflation within the forecast horizon is biased to the upside.

Although the shocks that have increased inflation are expected to be transitory, due to their variety, magnitude, and the extended horizon over which they have affected it, they may pose risks to the price formation process and to inflation expectations. In order to avoid such risks, it was deemed necessary to reinforce the monetary policy stance by adjusting it to the trajectory required for inflation to converge to its 3% target within the forecast horizon. The Governing Board decided to increase the target for the overnight interbank interest rate by 25 basis points to 4.75%.

For the next monetary policy decisions, the Governing Board will assess the factors that have an incidence on the foreseen trajectory for inflation and its expectations, in order for the policy rate to be consistent at all times with the orderly and sustained convergence of headline inflation to the 3% target within the time frame in which monetary policy operates, enabling an adequate adjustment of the economy and financial markets.

Voting in favor of the decision were Alejandro Díaz de León, Irene Espinosa, Galia Borja and Jonathan Heath. Voting in favor of leaving the target for the overnight interbank interest rate unchanged at 4.50% was Gerardo Esquivel."


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