Banco de la República year’s close

Hi everybody

To say the Banco de la República, Colombia’s central bank, has an agitated December, may be an understatement, in the last month of the year the Bank choose its new director Juan José Echavarría and cut its interest rate in 25 basic points to a 7.50% level. With all of this happening at the same time I think is useful to review the 2016 facts and try to get a glimpse of how the local monetary policy will behave in 2017.

If the former director José Dario Uribe has to dealt with the higher inflation in 2016 the new one, Juan José Echavarría will have to face the economy low growth rate and lack of dynamism, making a complete different scenario for monetary policy implementation. In order to get in depth with this topic is important review what are the main components of Colombia’s monetary policy.

The monetary policy controlled by the central bank deals mainly with the economy price level through the control of the amount of money in the market because reductions in its level will in turn reduce the home’s consumption leading to a price reduction. However, this policy decisions have an adverse effect in growth because the home consumption is an important element in the country’s Gross Domestic Product. That’s why the Bank has to balance the price and growth forces in order to achieve a long run sustainable growth rate, leading to the establishment of the inflation target framework which is an optimal price level for the economy, in Colombia this level is 3% +/- 1% which means the target is between 2% and 4%.

Made by the author. Data from DANE

Let’s not forget, at the end of the day this comes down to a supply demand problem and a rise in the price level can come from either a rise in demand or a drop in supply. That being said, is understandable the terrain the Banco de la República navigates in terms of monetary policy and this year has been particularly difficult with a growing inflation rate getting farther from the target in the first seven months driven by the reduction in food supply form weather particular conditions and the truckers strike in the middle of the year.

Facing this situation the Bank focus in the price level and took measures to reduce the amount of money in the economy, rising rates until eventually the temporary food pricing effects started to wear off rising supply levels and driving prices to the inflation target, having in November the first rate below 6% in all year. Taking this into account the bank is ready to face the other silently growing problem, the low growth in the economy and with a rate of 1.2% in the third quarter and lower tendency in the year the scenario is not a cheerful one. In real terms a single cut in rate for December is not going to change Colombia’s growth tendency, it will require a constant expansive monetary policy, contrary to the one taken in 2016, and a growing amount of money in the economy and the home’s consumption levels.

What I think is this surprise cut in rates is forward guidance from the central bank to the market basically saying the prices are moving toward its target is time to take care of the economic growth. Is probably in 2017 the rate cuts will not happen every month in order to protect the price lower tendency however they will make this decision every now and then to give the economy a bust.

That’s all for this week, have a merry Christmas!

*This post reflects the author’s opinion and mus not be taken as an investment recommendation.

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