Colombia Inflation ‘Surprise’ Looms After Rate Cut

Colombia’s unexpected interest-rate cut last week may lead to an inflation “surprise” later this year, Morgan Stanley said.

“The central bank’s decision to cut rates may be a signal that the authorities are focusing more on fighting currency appreciation and may have to pay the inflation costs of such a policy shift,” Morgan Stanley analyst Daniel Volberg wrote in a report today.

Banco de la Republica cut the overnight lending rate to a record low 3 percent on April 30, surprising all 31 analysts surveyed by Bloomberg who forecast the rate would stay at 3.5 percent. Central bank President Jose Dario Uribe said after the monetary policy meeting that while the economy is “recovering faster than expected,” the decision was based on slowing inflation expectations.

The peso is up 14.7 percent in the past 12 months, making it the third-best performer among major emerging-market currencies. It slumped 0.7 percent today to 1,987.51 per dollar and is down 4.6 percent since March 3, when policy makers announced they would buy $20 million a day in the foreign- exchange market through mid-year to curb a rally they say left the peso “misaligned.”

Year-End Inflation

An April 5 government report showed annual inflation slowed to 1.84 percent in March, its lowest level since 1955 and below the central bank’s inflation target for this year between 2 percent and 4 percent. The report led economists to reduce their year-end inflation forecast to a median estimate of 3.3 percent in a central bank survey last month from 3.7 percent in a March survey.

The government is slated to release its April inflation report tomorrow.

Morgan Stanley raised its forecast for year-end inflation to 4.4 percent from 4.1 percent. It expects Banco de la Republica to raise the key rate to 4.25 percent by the end of 2010, from an earlier estimate of 5.5 percent.

Colombia’s peso will continue to gain after “near-term” weakness following the central bank’s measures, Volberg wrote. Increased exports, “strong” foreign direct investment and rising commodity prices will lead the peso to jump to 1,850 by the end of 2010, according to Volberg. That compares with a previous estimate of 1,950.

“The central bank’s shifting focus to fighting currency appreciation may prove an uphill battle as we see significant fundamental support for a stronger peso,” he wrote.

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