Colombia unlikely to join global easing cycle - Capital Economics
Latin America Economics

Colombia unlikely to join global easing cycle

Latin America Economics Update
Written by Quinn Markwith

A number of major central banks in Latin America are on the cusp of joining the global easing cycle but, in contrast to the prevailing view, we don’t think that Colombia will be one of them. We expect a weaker Colombian peso to push inflation up in the coming months, leaving no room for rate cuts.

  • A number of major central banks in Latin America are on the cusp of joining the global easing cycle but, in contrast to the prevailing view, we don’t think that Colombia will be one of them. We expect a weaker Colombian peso to push inflation up in the coming months, leaving no room for rate cuts.
  • Inflation edged up from 3.1% y/y at the start of the year to 3.4% y/y last month, above the central bank’s 3% target. This has been driven largely by an increase in food inflation, which has been partially offset by a decline in fuel inflation. Meanwhile, core inflation has remained steady at around 3.0% y/y.
  • Looking ahead, we expect inflation to rise further over the coming quarters. This will be due in part to the weakness in the peso over the past 12 months. One point that’s been overlooked is that price inflation of those goods that tend to be most sensitive to currency weakness has already started to rise.
  • We have constructed an exchange rate sensitive inflation index, comprised of approximately 15% of the overall CPI basket. The items are for the most part imported or heavily reliant on imports and include vehicles, jewellery, televisions, music equipment, shoes, home utensils, housing utilities and appliances.
  • Chart 1 shows that our inflation sensitive index has had a fairly good relationship with the Colombian peso over the past 15 years or so. Inflation in this basket of goods has risen by around 0.5%-pts since the start of the year, suggesting that currency weakness has indeed already started to push up the headline rate.
  • Chart 1 also makes the point that it takes six-to-nine months for currency moves to feed into inflation. The peso has been one of the worst performing EM currencies over the past year. On past form, currency weakness over the past six months or so will push up our measure of exchange rate sensitive inflation by around 3.0%-pts. That would add around 0.5%-pts to the headline inflation rate.
  • What’s more, we expect the peso to weaken further. Colombia’s current account deficit, which widened to 4.3% of GDP in Q1 (on a four-quarter sum basis), is one of the largest among major EMs. This makes the peso vulnerable to the deterioration in risk appetite that we think will play out in the coming quarters. (For more detail, see here.) We’ve pencilled in a 10% drop in the peso against the dollar from 3,200/$ now to 3,650/$ by year-end. This will keep the peso weak in y/y terms (which is what matters for inflation).
  • Food inflation is also set to rise. Based on our forecast for higher global agricultural prices (see Chart 2), a rise in food inflation could add a further 0.5%-pts to the headline rate over the next twelve months. All told, we think that these factors will cause the headline rate to breach the upper-bound of the central bank’s 2-4% target range by year-end.
  • Against that backdrop, we think that the markets are too dovish in pricing in a 25bp cut over the next six months. We think that the next move is more likely to be up.

Chart 1: Consumer Prices & Exchange Rate (% y/y)

Chart 2: Food Inflation & GSCI
Agricultural Index

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


Quinn Markwith, Latin America Economist, +44 20 7808 4072, quinn.markwith@capitaleconomics.com