Peru Likely to Keep 4.25% Rate After Stemming Sol’s Appreciation

Peru’s central bank probably will keep borrowing costs unchanged today for a 22nd consecutive month after weakening the sol and reining in credit growth.

The five-member board, led by bank President Julio Velarde, will leave the overnight rate at 4.25 percent, the lowest in Latin America after Colombia, according to all 14 economists surveyed by Bloomberg. The decision will be announced at about 6 p.m. in Lima.

The sol had the biggest two-month decline to start a year since 2009 after the central bank raised dollar reserve requirements three times since Jan. 1 and stepped up purchases of U.S. currency. While the lowest inflation rate in two years gives policy makers room to consider cutting rates to slow dollar inflows, domestic demand remains too strong, said Francisco Rodriguez, a senior Andean economist at Bank of America Corp.

“There are no major signs of deceleration in activity,” Rodriguez said in a telephone interview from New York. “The only reason to cut would be to weaken the sol and what they’ve been doing at the level of reserve requirements is helping” to reverse the currency’s gains, he said.

The sol appreciated 5.7 percent in 2012 amid a surge in foreign direct investment to a record $12.2 billion and demand for local government bonds. The currency has declined 2.2 percent this year after the central bank bought $3.4 billion in dollars, double what it purchased in the last two months of 2012. The Finance Ministry has pledged to buy at least $4 billion in 2013 to soak up surplus greenbacks.

Rate Outlook

The monetary authority may lower interest rates if inflation conditions allow, research director Adrian Armas told reporters after last month’s meeting, and Velarde said Jan. 25 policy makers wouldn’t rule out rate reductions.

Peruvian consumer prices surprised economists by dropping 0.09 percent last month as food prices fell, pushing annual inflation down to a two-year low of 2.45 percent. Policy makers after last month’s meeting said they expect inflation “in the coming months” to converge to their target range of 2 percent plus or minus 1 percentage point.

While Brazilian policy makers grapple with rising prices in Latin America’s biggest economy, slowing inflation is giving other central banks in Latin America leeway to stimulate growth amid weak demand in developed economies.

Mexican central bank Governor Agustin Carstens said Feb. 13 that Banxico may cut interest rates after inflation returned to its target range for the first time since May, while Colombia’s monetary authority has lowered borrowing costs 1.5 percentage points since June.

Peruvian economic activity expanded 4.3 percent in December, the slowest pace in three years, on a dip in construction, a mainstay of the $200 billion economy.

Peruvian Demand

Still, growth of gross domestic product in 2013 will probably match last year’s 6.3 percent expansion, which was the fastest in South America, according to Banco de Credito del Peru.

“There are no signs of demand cooling,” said Juan Carlos Odar, a senior analyst at the Lima-based bank, the country’s largest. “Domestic demand is growing faster than GDP, so there’s no need to move rates.”

The yield on Peru’s benchmark 7.84 percent sol-denominated bond due August 2020 has fallen 11 basis points, or 0.11 percentage point, to 3.77 percent this year after dropping 1.87 percentage point in 2012. The Lima General Index has fallen 0.3 percent after a 5.9 percent gain in 2012.

Curtail Demand

The central bank has bolstered a drive to curtail demand for car loans and mortgages in dollars after six increases in reserve requirements for soles last year damped demand for credit in local currency.

While total lending to companies and households rose 14.2 percent in January, the slowest annual pace since 2010, demand for car loans, credit card borrowing and mortgages in dollars climbed at rates as high as 39 percent, the central bank said in a March 5 report. The greenback accounted for 43 percent of all loans in the country in January and 37 percent of all deposits.

Policy makers will extend their interest-rate pause, the longest since the bank began targeting inflation in 2002, as they monitor the effects of recession in Europe and budget cuts in the U.S., the main destination for Peru’s exports, said Bank of America Corp.’s Rodriguez.

By flagging the possibility of a cut, policy makers “are saying we’ve got inflation in the target band so we’ve got room to act in whatever direction is necessary in terms of monetary policy,” he said.