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Colombia Shows How Not to Wage Peso War With Rates: Currencies

Colombia's Central Bank Governor Jose Dario Uribe
Jose Dario Uribe, governor of Colombia's central bank, said it was never policy makers’ goal “to seek or defend a level of the nominal or real exchange rate.” Photographer: Chris Ratcliffe/Bloomberg

Colombia is showing the world how not to wage a currency war.

While the authorities stepped up their purchases of dollars last month to stem the peso’s rally, the central bank followed up days later by unexpectedly raising interest rates, boosting the currency’s appeal. That contributed to the peso’s 6.1 percent rally in the past two months, the biggest gain among 24 emerging-market currencies tracked by Bloomberg. Strategists in Bloomberg surveys boosted their year-end peso forecasts by 1.7 percent in April, more than for any of its Latin American peers.

“It’s like driving a car with one foot on the accelerator and another on the brake,” John Welch, a macro strategist at Canadian Imperial Bank of Commerce in Toronto, said in an April 29 phone interview. “If intervention works against the monetary stance they’re taking, they tend to cancel each other out.”

In actions reminiscent of the competitive devaluations of 2010, which Brazilian Finance Minister Guido Mantega termed a currency war, developing nations from the Czech Republic to South Korea have in recent months intervened in foreign-exchange markets or cut rates to make their economies more competitive. Colombia’s an example of how such efforts can go wrong.

Worrisome Level

“They may end up regretting the rate hike,” Win Thin, the global head of emerging-market strategy at Brown Brothers Harriman & Co., said in a phone interview from New York on April 29. “The peso looks set to strengthen from these levels -- 1,900 is the area where they’ll get more worried.”

Colombia’s peso climbed to a five-month high of 1,913.7 per dollar on April 8, from 2,065.7 in February, the weakest level since September 2009. Its recent gains wiped out the 4.3 percent loss during its worst January since 2009, and left it little changed on the year at 1,925.88 as of the end of last week.

While strategists surveyed by Bloomberg see the peso falling by year-end, they’ve become more optimistic in the past month. The median of 16 estimates puts the peso more than 2 percent weaker by Dec. 31 at 1,975 per dollar, compared with a forecast of 2,010 on March 31.

Banco de la Republica Colombia, the central bank, has bought an average of $19 million a day in the currency market since April 21, up from an average of $10.5 million from April 1 to April 16.

Policy Rate

The central bank plans to use the $1 billion limit of its second-quarter dollar purchase program to protect the country from a possible reversal of capital flows, according to co-director Adolfo Meisel. Higher demand from overseas investors for Colombia’s local bonds means the country needs a bigger cushion of reserves to insure itself against changes in investor sentiment, Meisel said in an interview on May 2.

Andres Pardo, the head analyst at Bogota, Colombia-based Corporacion Financiera Colombiana SA, said policy makers may extend purchases beyond June. Pardo, whose firm is a unit of the nation’s largest banking group, predicted the central bank will lift its policy rate to 4.75 percent by year-end, after it was raised a quarter percentage-point to 3.5 percent on April 25 to combat inflation.

“In terms of the exchange rate, it’s obviously not the best timing for a rate hike,” Pardo said by phone on April 28. “Higher rates mean further appreciation pressures on the peso.”

The central bank’s press office declined to comment on its monetary policy when contacted by Bloomberg News. In a Feb. 7 interview at the bank’s headquarters in Bogota, Governor Jose Dario Uribe said it was never policy makers’ goal “to seek or defend a level of the nominal or real exchange rate.”

Intervention Intention

Finance Minister Mauricio Cardenas, on the other hand, has been candid in saying the buying of dollars was intended to weaken the peso. He told reporters in Bogota on April 21 that accelerating purchases would counteract peso gains, after arguing last year that the strong currency was the “mother of all problems” for Colombia.

Colombia’s actions to depreciate the currency are reminiscent of other emerging-market nations. The Czech Republic intervened in November for the first time in 11 years, imposing a cap of about 27 koruna per euro, which its currency hasn’t broken through since. A series of rate cuts by Hungary’s central bank have helped weaken the forint by 3.4 percent versus the euro this year.

The South Korean won and Taiwanese dollar have both appreciated since March amid speculation policy makers have wound down months of intervention.

Key Indexes

Colombia’s peso was supported after JPMorgan Chase & Co. said March 19 it may more than double the weighting of the nation’s local-currency bonds in two of its key debt indexes. The central bank’s dollar-purchase program is dwarfed by the more than $9 billion inflows that JPMorgan estimates will follow the changes.

Cardenas told reporters after the April 25 rate increase that analysts are overestimating inflows following JPMorgan’s announcement and that the peso will fall “toward its equilibrium,” which he has previously said is about 1,950, or more than 1 percent weaker than current levels.

The reduction in the U.S. Federal Reserve’s bond-purchase program will buoy the dollar at the expense of the peso, which will slide toward 1,975 by year-end, according to Hector Suescun, an analyst at Banco de Bogota, the South American nation’s second-biggest bank. Colombia’s rate increases will have little impact on the currency as investors have already accounted for higher borrowing costs, he said on April 30.

Chile, Mexico

Faster economic growth means the Colombian peso will outperform its Chilean and Mexican counterparts, according to Mike Moran, a senior currency strategist at Standard Chartered Plc in New York.

“This is pretty much a textbook case of a currency appreciation story: an economy which is recovering ahead of the regional curve and domestic interest rates are increasing,” Moran said in a phone interview from New York on May 2. He predicted the peso will end the year more than 5 percent stronger at 1,825 per dollar.

The Andean nation’s currency has strengthened in eight of the past 11 years, with an 8.4 percent slide in 2013 failing to wipe out the previous year’s 9.7 percent advance. Those gains contributed to a slump in industrial output, even as record foreign investment powered growth in areas such as mining and energy. Colombia’s economy grew 4.9 percent in the fourth quarter from a year earlier, faster than Chile, Mexico and Brazil.

The rate increases will continue to support the peso, said Steffen Reichold, an emerging-markets economist at Stone Harbor Investment Partners LP., which oversees $63 billion.

“You can slow the pace of appreciation but you cannot avoid it,” New York-based Reichold said in an April 28 phone interview. “Especially in an environment where you raise rates.”

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