Peru Central Bank Raises Rate More Than Forecast to 2.5% on Inflation Risk

Peru’s central bank raised its benchmark lending rate more than economists forecast to prevent inflationary pressures arising from the “spectacular” economic growth being forecast by bank chief Julio Velarde.

The seven-member board increased its reference rate by a half-point to 2.5 percent from 2 percent, surprising 15 of 16 economists surveyed by Bloomberg who forecast a quarter-point rise. One economist expected a half-point rise.

South America’s sixth-biggest economy is growing at a “very robust pace” as domestic demand strengthens, posing a challenge for the central bank as it seeks to keep prices under control, said Juan Pablo Fuentes, chief economist at Moody’s Economy.com. The annual inflation rate has risen from 0.25 percent in December to 1.82 percent in July, near the middle of the bank’s 1 percent to 3 percent target

“Once inflation tops 2 percent, the market will start to worry about inflation being over target,” Fuentes said in a phone interview from West Chester, Pennsylvania. “The central bank wants to keep inflation expectations in check.”

Today’s interest rate increase was “preventative” and comes within the context of strong internal demand, the bank said in a statement. The board will monitor inflation projections in a bid to adopt monetary policy that will guarantee inflation remains within the bank’s target range.

The bank said in June it expects annual inflation to reach 2 percent to 2.5 percent by year-end.

Demand, Response

After the economy expanded 0.9 percent last year, the slowest pace since 2001, increased company spending and rising inflows have helped push Peru to its fastest growth since 2008.

Peru was the second Latin American country after Brazil to raise borrowing costs in 2010 as a recovery in private investment spurred domestic demand. Chile increased its lending rate by 0.5 point for a second month in July as economic growth accelerates.

Peru’s economy expanded 9.2 percent in May from a year earlier and may post “spectacular” growth of close to 10 percent for June, Velarde told reporters July 22.

Although price growth remains under control, rapid economic expansion risks fueling inflation, Velarde said.

“As long as internal demand is projected to see vigorous growth, the monetary stimulus will continue to be withdrawn” at a pace determined by economic data, Velarde said.

The annual inflation rate rose to 1.82 percent in July, an 11-month high, the National Statistics Institute said Aug. 2. Prices rose 0.36 percent from June.

Economy’s Effect

Alberto Ramos, a Latin America economist at Goldman Sachs Group Inc., said in an Aug. 2 research note that a year-end inflation rate above the target’s upper limit of 3 percent couldn’t be ruled out because of the improving economy.

Last month, policy makers raised deposit requirements for banks, following an increase in June, to ensure an “orderly” development of liquidity and credit. Private sector credit and liquidity each climbed 16 percent in June from the same month a year earlier.

“Peru’s economy is growing faster than any other in the region, generating strong demand for commercial and retail credit,” Jose Antonio Rosas, chief financial officer of Peruvian financial holding Intergroup Financial Services Corp., said in a July 27 conference call with analysts. “We expect 20 percent growth overall in our loan portfolio this year.”

Rebounding manufacturing, construction and retail output led to a 7.4 percent rise in gross domestic product in the first five months of 2010.

Rate Horizon

The central bank’s business confidence index rose to the highest level since 2007 in June, with transport, telecommunications, services and construction companies the most optimistic about the outlook for their industries.

The bank raised its 2010 growth forecast to 6.6 percent in June, up from 5.5 percent. Annual inflation may accelerate to 2 percent to 2.5 percent by year-end, the lowest rate among Latin America’s major economies, according to the bank.

“We don’t see the central bank stopping raising rates in the foreseeable future,” said Alonso Segura, head of research at Banco de Credito, Peru’s biggest bank, in a July 21 interview. The reference rate may reach 3.25 percent at the end of the year and close to 5 percent next year, Segura said.

Surging output has led to a rise in foreign demand for Peru’s sol, and more aggressive intervention by the central bank, which bought a record $494 million in the foreign exchange market July 14.

Purchases totaling $1.86 billion last month helped swell net foreign currency reserves to a record $38 billion as of July 20, compared with $35 billion as of June 30.

“A strong currency is good for inflation but bad for the economy because it punishes local producers when they can’t compete with imports,” Fuentes said.

The sol has gained 5.3 percent in 12 months, the ninth-best performance against the dollar among 26 emerging market currencies tracked by Bloomberg.

To contact the reporter on this story: John Quigley in Lima at jquigley8@bloomberg.net; Helen Murphy in Bogota at hmurphy1@bloomberg.net

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