Colombia - Economic Briefing August 2003

Decelerating Inflation Keeps Interest Rates Low  (continued)

Inflation continues on downward path
In July, consumer prices dropped 0.14%, which was up from the 0.05% decline in the previous month and represented the second consecutive monthly drop in consumer prices. The key driver behind the July price drop was a decline in food prices and culture/entertainment prices. Only higher health and transport price hikes offset the monthly downward trend, as most other categories remained virtually unchanged. As a result of the July drop in consumer prices, annual inflation fell 0.2 percentage points over June to 7.0%. The current price developments, in part, reflect seasonal factors but also the downside effect of the recent currency appreciation. Central Bank officials are confident that the current downward trend in inflation will continue and will enable the compliance with this year’s 5% to 6% inflation target. However, officials remain concerned that current public service price hikes could threaten the goal. According to the July data, the accumulated increase in energy prices this year reached 9.0%, while residential telephone tariffs have risen 9.1%. The current moderation in consumer prices is helping to lower annual inflation but given that accumulated inflation in July reached 4.9%, compliance with the annual target is likely to be difficult. In fact, participants expect the Central Bank to overshoot with this year’s annual inflation rate expected at 6.6%, which is unchanged from last month.

Interest rates inch up but remain historically low
Despite the more pronounced currency weakening in July – the peso depreciated 2.4% to the US$ - the Central Bank continues to maintain an accommodative monetary policy stance, as economic activity remains moderate and inflation appears to be declining. The July depreciation in the currency followed upon three consecutive months of appreciation, which resulted from Central Bank intervention in the exchange rate market. Concerns about the possibilities that further appreciation could undermine competitiveness in export markets gained via the currency weakening earlier in the year is likely to have influenced the Central Bank’s decision to raise the benchmark DTF interest rate only moderately in July. The DTF rate was raised by only 2 basis points in July, following the 5 basis point increase in June. So far this year, the DTF rate has been raised by 13 basis points only and at the current 7.8% remains at historical lows. If economic activity rebounds and a trend of more accelerated currency depreciation emerges, the Central Bank may have to tighten the monetary reins. Consensus participants expect rates to increase in the second half of the year but have lowered their forecast again to reflect a more favourable rate environment this year. As a result, the DTF rate is now expected to reach 8.6% at the end of the year, which is down a 0.1 percentage point from last month. More accelerated currency depreciation and heightened economic activity are also likely to prompt further tightening next year with the DTF expected to rise further to 9.5%.