Banco de la República Lowers its Intervention Interest rate by 25 Basis Points

In its meeting today, the Board of Directors of Banco de la Republica ratified their commitment to keep the inflation target at 3% and confirmed that the monetary policy measures will continue to be directed towards holding inflation at that value. Low and stable inflation is the best contribution monetary policy can make to sustainable economic growth and the creation of jobs. The 3% inflation also applies in the legal area and the target range is 3% +/- 1 percentage point.

In addition, the Board decided to reduce the benchmark interest rate by 25 basis points.  Therefore, the base rate used in liquidity-expansion auctions is 4.5%. This decision was based on the following considerations:

The international uncertainty is still present. Some international economic indicators have improved a little. The weakness in a significant number of industrialized economies and the lack of inflationary pressure make it possible to expect that foreign interest rates will remain low for an extended period of time.

Colombian growth has slowed down based on rates that were seen to be above their trend levels in the second half of 2011.  After a 4.8% annual growth in the first half of 2012, the recent indicators of activity suggest that growth is moderating slightly more than what was expected. The weakness in the worldwide economy and the slowdown in domestic demand have been reflected in the lower growth in exports and the contraction in industrial output. The forecast range for GDP growth in 2012 is between 3.7% and 4.9% with 4.3% as the most likely result.

At its meeting today, the Board of Directors of Banco de la República decided to reduce the benchmark interest rate by 25 basis points, thereby placing the base overnight rate for expansion auctions at 4.25%. This decision was taken in light of the following:

• Third-quarter GDP growth in 2012 (2.1%) was below the target range forecast Banco de la Repúplica’s technical team (between 3.3% and 4.8%). Internal demand slowed significantly, from 7.1% in the second quarter to 2.4% in the third. This is explained entirely by a sharp and unexpected contraction in investment, particularly investment in the civil works and buildings. In terms of civil works, there were substantial reductions in investment in mining and the construction of highways and other routes.  The drop in investment in buildings affected housing as well as non-residential constructions.
• In contrast, the increase in private and public consumption during the third quarter (4% and 4.8%, respectively) was similar to what was observed in the second quarter and slightly better than expected.  Exports, which rose by more than 11% in real terms during 2011, have slowed so far in 2012 and were up by 2.5% during the third quarter. This reflects, to a large extent, the impact of the global slowdown on Colombian foreign trade.  In addition, real import growth declined from 21.5% in 2011 to 8.8% during the third quarter of 2012, in keeping with the reduced momentum in internal demand.
• Recent figures on the global economy indicate no significant change in what was reported in the bulletin on the previous meeting of the Board of Directors. International uncertainty remains. Some international economic indicators have improved slightly, but foreign interest rates are expected to remain low for an extended period of time, given the weakness in a number of industrialized economies and the lack of inflationary pressures.
• The foregoing results and the new economic figures for the fourth quarter of 2012 suggest growth for the year as a whole could be less than 4%. Once again, the major uncertainty in this forecast originates with investment performance, mainly investment intended for civil works and buildings
• Some of the factors that slowed investment in 2012 are expected to reverse in 2013, thereby bolstering internal demand. Such is the case, for example, with several investment projects in the mining-energy sector, which have suffered delays this year.    Something similar is expected to happen with respect to the construction of highways and other routes. The conditions that support the momentum observed in consumption and investment in machinery and equipment should continue during 2013.   These include, among others, the stable levels of employment and consumer confidence and the reduction in policy interest rates witnessed during the second half of 2012. The latter are being passed through to the interest rates on lending. Finally, with respect to the external context, the expectation is for slightly more global economic growth than in 2012, relatively stable terms of trade, and abundant international liquidity.
•  In these conditions, economic growth during 2013 is expected to exceed the forecast for this year.
•  The results for inflation in November were less than expected, primarily because of the way prices for food and regulated items behaved. Inflation, the average of the core inflation indicators and most measurements of inflation expectations are below the 3% target.  Given the new information at hand, this situation is expected to continue for some time.

In short, the Colombian economy is growing at a rate below its potential. Both observed and forecast inflation are below the 3% target, and there are no signs of upward pressure on inflation in the future.  With these circumstances, an assessment of the risk balance points to the desirability of reducing the intervention interest rate to 4.25%. The action taken with respect to monetary policy is aimed at placing output in 2013 near the economy's productive capacity, without threatening the inflation target and the country's macroeconomic stability.

The Board reiterated that Banco de la República has the tools and resources to meet the liquidity needs the economy regularly has in terms of both local and foreign currency, as well as any needs that could arise in an environment of international financial turmoil.

The Board will continue its careful monitoring of performance and projections with respect to economic activity and inflation in Colombia, asset markets and the international situation. Finally, it reiterated that monetary policy will depend on whatever new information becomes available.