(Updates prices in second paragraph.)
Feb. 23 (Bloomberg) -- Colombian inflation is poised to accelerate to the upper end of the central bank’s target range even after eight interest-rate increases in the past year aimed at holding down consumer prices, credit-market measures show.
The gap between yields on government inflation-indexed bonds due in 2013 and similar-maturity fixed-rate debt, a gauge of annual consumer price increase expectations, stood at 3.9 percentage points today and reached an 11-month high of 4.07 on Feb. 17. The break-even rate has risen 12 basis points, or 0.12 percentage point, since policy makers unexpectedly raised the benchmark rate 25 basis points to 5 percent on Jan. 30.
Policy makers meeting tomorrow will lift the overnight lending rate to 5.25 percent as the fastest economic growth since 2006 threatens to quicken annual inflation from 3.54 percent in January, according to 21 of 32 economists surveyed by Bloomberg. Banco de la Republica’s interest-rate increases come as central banks in Brazil, Chile and Russia cut borrowing costs to safeguard against a global economic slump.
“The risk is for inflation to spiral out of control,” said Felipe Campos, the head analyst at Alianza Valores brokerage in Bogota. “Banco de la Republica will continue to react, especially as inflation expectations remain near or above the top end” of the 2 percent to 4 percent target, he said.
Trading in three-month interest-rate swaps reflect bets that policy makers will next raise rates by 25 basis points in March while a majority of economists in a central bank survey published Feb. 10 forecast no change this month and an increase to 5.5 percent by year-end. Eleven analysts in the Bloomberg survey predict no change at tomorrow’s meeting.
In the statement accompanying last month’s decision, policy makers cited rapidly-expanding credit, “strong” growth and rising inflation expectations for the surprise increase, which was forecast by only one of 32 economists surveyed by Bloomberg.
In a Feb. 15 presentation titled “Why did the board raise interest rates,” central bank co-director Juan Jose Echavarria said inflation expectations are “little anchored” and high foreign direct investment, which is helping fuel growth, “depends little on dynamics in the world economy.”
Policy makers forecast gross domestic product growth in Colombia may be as high as 6 percent this year after a similar expansion predicted for last year. GDP expanded 7.7 percent in the third quarter from a year earlier, a pace that even surprised them according to last month’s statement.
The government forecasts foreign direct investment will rise to $16 billion this year, from a record $14.5 billion last year, as companies search for oil, coal and gold in areas that were once overrun by guerrillas and considered too dangerous to explore.
Annual inflation has decelerated for three months after breaching the upper limit of the 2 percent to 4 percent target range in October for the first time since 2009.
Policy makers are focused on reaching the mid-point of the target, Finance Minister Juan Carlos Echeverry, who is also president of the central bank board, said in a Feb. 9 interview.
Colombia needs to continue raising borrowing costs to ward off inflation as the economy shows few signs of slowing, said Daniel Nino, the head analyst at Bancolombia SA, the nation’s biggest bank.
“As things are going, growth will surpass even the most optimist of forecasts,” Nino said. “The possibility that the economy will grow more this year than last is rising and that is something no one had in the cards.”
As higher interest rates risk pressuring more gains in the peso, Banco de la Republica will likely refrain from raising interest rates further this year and instead adopt measures to curb lending such as higher reserve requirements, said Carmen Salcedo, an analyst at financial services holding company Corp. Financiera Colombiana, known as Corficolombiana.
In a bid to ease gains in the peso, which has climbed 9.1 percent this year, the central bank began buying a minimum of $20 million daily in the foreign-exchange market for at least three months beginning Feb. 6.
Banco de Republica would like to see a weaker and more stable peso, Echavarria said in the Feb. 15 presentation. The peso, the third-best performer in the past six months among 25 emerging-market currencies tracked by Bloomberg, rose 0.3 percent today to 1,776.44 per U.S. dollar.
“In an external context of low interest rates, by raising rates you make the carry trade even more attractive,” Salcedo said. The carry trade refers to the practice in which investors borrow funds in a country with lower borrowing costs and buy assets where interest rates are higher.
Colombia’s interest rate compares to near zero in the U.S.
While acknowledging the risks of slower worldwide growth and “the not yet dissipated risk of Greece not paying its debt,” policy makers cited domestic economic factors as the motivation for January’s increase, according to minutes of the meeting.
“Excessive credit growth and the persistence of low real interest rates might become a source of financial unbalances with negative effects on the sustainability of economic growth,” the central bankers said in the minutes.
Colombia’s central bank will need to follow through with more interest rate increases as its “hawkish” comments spark a surge in inflation expectations, said Francisco Chaves, a strategist at Bogota-based brokerage Corredores Asociados SA.
“The market was very focused on what is happening abroad, almost to the point where we pretty much ignored third-quarter growth,” Chaves said. “The central bank’s hawkish tone, which shined a light on inflation risks coming from rising demand, changed investors’ mind set.”
--With assistance from Dominic carey in Sao Paulo. Editors: Brendan Walsh, Robert Jameson
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