Banco de la República Lowers the Benchmark Interest Rate by 25 Basis Points and Expands its Daily Reserve...

Complete tittle: Banco de la República Lowers the Benchmark Interest Rate by 25 Basis Points and Expands its Daily Reserve Purchase Program

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%. This decision was taken in view of the following factors:

• On the international front, average economic growth in 2012 with respect to Colombia’s trading partners was consistent with expectations.  For 2013, the measures adopted by the European authorities and the improvement in financial conditions have reduced the likelihood of a sharp recession in the Euro Zone. In the United States, the latest information suggests its economy could grow at a somewhat slower pace than was estimated for 2012.  China’s growth remains at around 8%.  This being the case, the expectation for the current year is that external demand will remain weak and grow at a pace similar to the rate in 2012.
• The rising trend witnessed in terms of trade up to 2011 was interrupted in 2012, the year when terms of trade remained stable. Given the weakness of the global economy, terms of trade in 2013 could be somewhat less than the average observed in 2012.
• As to the fourth quarter of 2012, the new figures on consumer lending, retail trade and consumer confidence suggest household spending would grow  at a rate slightly less than the one observed in the third quarter. There is a great deal of uncertainty about how investment will behave, especially investment spent on civil works, construction and buildings. The figures for exports in dollars show more of a slowdown than for imports.
• On the supply side, the industrial production indicator posted an annual drop in November and expectations in the sector deteriorated yet again. Retail sales, both with and without vehicles, rose at a good pace.
• The technical team forecasts between 2.5% and 4.5% economic growth for 2013, with 4% being the most likely figure. The major uncertainty with respect to this forecast is rooted in the possible persistence of the negative shock witnesses in investment in civil works and buildings. Some of the factors that have slowed this type of spending are expected to be reversed, thereby bolstering domestic demand. The conditions that supported the momentum observed in consumption and in the investment in machinery and equipment are expected to continue during 2013. Among others, these include stable levels of employment and consumer confidence, and the accumulated reduction in policy interest rates. The latter is being passed through to interest rates on loans, coupled with lending that has slowed but continues to grow at a good pace. All of this is accompanied by an international context of broad liquidity and low interest rates.
• Annual consumer inflation in December (2.4%) declined more than anticipated by the market and by the Bank’s technical team. As occurred throughout the year, the slowdown in inflation was explained, yet again, by less of an increase in the CPI for regulated items and food. Average core inflation and inflation expectations declined again and are now below the long-term target (3%).

In short, the Colombian economy is growing below its potential, both observed and projected inflation are under the 3% target, and there are no signs of upward pressure on inflation in the near future.  Given these conditions, an assessment of the risk balance indicates the advisability of lowering the intervention interest rate to 4%. The monetary policy action that has been taken is designed to situate output in 2013 close to the economy’s productive capacity, without jeopardizing the inflation target or the country’s macroeconomic stability.

The Board of Directors also decided to continue to accumulate international reserves in an effort to maintain a proper balance in proportion to the country’s financial depth and its growing participation in the global economy. Accordingly, the Board extended the program for daily auctions to purchase foreign currency and Banco de la República will accumulate at least USD 3 billion between February and May of this year, through daily purchases of no less than US$ 30 million. This represents an increase from USD 500 million in average monthly purchases under the previous program to no less than USD 750 million under the current one.  The decision takes into account the recent trend toward peso appreciation in an environment characterized by an expansive monetary policy, weak export growth compared to the increase in imports, and an uncertain outlook for terms of trade.

The Board reiterated that Banco de la República has sufficient tools and resources to satisfy the economy’s regular liquidity needs with respect to both local and foreign currency, as well as any needs that could arise in an environment of international financial turmoil.

The Board will continue to carefully monitor 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 new information as it becomes available.