Bloomberg News

Peru Signals Readiness to Respond After Keeping Rate at 4.25%

May 11, 2012

Peru’s central bank kept borrowing costs unchanged yesterday for a 12th month and signaled its readiness to respond to any shifting inflation expectations after boosting reserve requirements to tame credit growth.

The seven-member board, led by bank President Julio Velarde, maintained the overnight rate at 4.25 percent, matching the forecasts of all 16 economists surveyed by Bloomberg.

“The board is monitoring the outlook for inflation and its determinants so it can consider additional adjustments to monetary policy instruments,” the central bank said in a statement posted on its website.

Peru raised the amount of money banks must deposit at the central bank on May 1 for the first time in a year as the economy expanded faster than expected and credit demand accelerated. Further increases in reserve ratios may be needed to rein in above-target inflation and restrain the sol’s 5.4 percent rally against the dollar in the last 12 months, said Mario Guerrero, an economist at Scotiabank Peru.

“The bank will use reserve requirements to keep a lid on liquidity and the currency and only raise interest rates if inflation persists and inflation expectations rise,” Guerrero said in a phone interview from Lima.

Growth is quickening in South America’s sixth-largest economy after a rebound in business confidence as the government rolls out infrastructure-focused stimulus measures to offset weaker demand for the country’s metal exports.

Convergence

Economic activity expanded 7.2 percent in February, the fastest pace in six months, after the outlook for global growth improved and President Ollanta Humala took steps to mollify protests that have delayed mining investments.

The central bank may raise its 2012 growth forecast to as much as 6.2 percent from a March 23 projection of 5.7 percent on stronger investment growth, Velarde told investors and reporters during an April 27 conference call.

Inflation, which slowed to 4.1 percent in April, will return to the central bank’s 1 percent to 3 percent target toward the end of this year, he said.

Policy makers yesterday said that “while internal supply shocks are being observed, their impact on inflation is expected to revert with greater intensity beginning mid-year, so that the annual inflation rate converges to the target range.”

Inflation expectations are within the central bank’s target range, they said.

Consumer prices rose 0.5 percent last month, keeping the annual rate above 4 percent for a seventh month, as food and fuel prices climbed, the national statistics agency said May 1. The median estimate of 13 economists in a Bloomberg survey was for a 0.35 percent rise.

Inflow Concern

By keeping lending rates unchanged, the bank runs the risk of inflationary pressures in non-food segments intensifying, said Daniel Volberg, an economist at Morgan Stanley.

“With its currency still under pressure to strengthen, the central bank appears concerned that hiking interest rates might simply fuel even stronger inflows,” Volberg wrote in a May 7 report. Still, he predicts the bank will raise its benchmark rate by as much as 75 basis points this year.

The central bank has bought $8 billion in the spot currency market this year to slow appreciation as companies and households switch their savings to soles from dollars and foreign investors buy Peruvian government bonds.

Peru’s international reserves rose to $57.5 billion as of April 30, from $48.8 billion at the end of December, because of the bank’s dollar purchases.

The sol touched 2.6330 per U.S. dollar on May 2, its strongest since 1997. Its 12-month rally represents the best performance against the dollar among 25 emerging market currencies tracked by Bloomberg worldwide.

Dollars, U.S. Rates

The central bank described the increase in reserve requirements as a “preventive” move to tighten money supply after companies stepped up borrowing in dollars to take advantage of record-low interest rates in the U.S.

Annual growth in bank lending rose 17.6 percent on a seasonally-adjusted basis, the fastest since September, led by demand for credit in dollars, the central bank said May 8.

The bank wants to make the financial system less vulnerable in the case of a sudden depreciation in the sol that would make it more costly for borrowers to pay back their dollar loans, which constitute 44 percent of all bank credit.

‘Continue Monitoring’

“We expect the central bank to continue monitoring the dollarization situation very closely and will preventively use reserve requirements to prevent credit growth and currency mismatches in the private sector’s balance sheet from getting out of hand,” Citigroup Global Markets Inc. Latin America economist Camilo Gonzalez wrote in a research note e-mailed to investors.

Though the increase to reserve requirements may have eased pressure on the central bank to raise its benchmark rate in the short term, the two policy tools usually go hand in hand, said Dirk Willer, the head of Latin American local markets strategy at Citigroup Inc.

The bank’s move “shows growth is probably a little bit too strong,” Willer said by phone from New York. “If food prices start to go up again, inflation could easily miss the central bank’s target.”

To contact the reporter on this story: John Quigley in Lima at jquigley8@bloomberg.net.

To contact the editor responsible for this story: Joshua Goodman at jgoodman19@bloomberg.net.


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