Peru Keeps 4.25% Rate on CPI Outlook Amid Near Potential Growth

Peru’s central bank kept borrowing costs unchanged for a 23rd consecutive month as policy makers expect inflation to converge to the mid-point of their target amid near-potential economic growth.

The five-member board, led by bank President Julio Velarde, yesterday maintained the overnight rate at 4.25 percent, matching the forecasts of all 10 economists surveyed by Bloomberg.

“The decision is based on the fact that inflation is within the target range in a context of economic growth close to its potential,” policy makers said in a statement posted on the central bank’s website.

Inflation remains within policy makers’ target range even after a surge in consumer prices last month, allowing the central bank to focus on slowing capital inflows that pushed the sol to a 16-year high in January. Four increases in dollar reserve requirements this year triggered a 1.2 percent decline in the sol, helping to reduce the allure of dollar credit.

“The main source of risk is from rapid currency appreciation and the implications for company and household balance sheets,” said Hedmond Rios, an economist at Celfin Capital, by phone from Santiago. “Inflation is secondary given that it’s converging to 2 percent this year.”

The sol had its biggest quarterly decline since 2008 in the first three months of the year as the central bank bought $4.4 billion of U.S. currency and allowed pension funds to increase holdings of overseas assets.

Dollar Credit

The bank has focused on dollar credit, which accounts for 43 percent of all outstanding loans, after using reserve requirements to damp sol lending.

Local currency loans expanded at an annual rate of 15.5 percent in February, the slowest pace in almost three years. Dollar credit in the same month rose 14 percent, after a 13 percent climb in January.

Double-digit dollar credit growth, fueled by the sol’s four-year rally and U.S. monetary stimulus, remains a concern for the bank, Velarde told reporters March 22.

While the central banks of Brazil, Chile, Colombia and Mexico have all cut borrowing costs in the last 16 months to protect their economies from slower growth in China and the U.S., Peru has extended its longest interest-rate pause since the country began targeting inflation in 2002.

‘Other Things’

The nation’s retail and construction boom fueled economic growth of 6.3 percent last year, the fastest in South America. Velarde, in an April 8 interview in Miami, said he expects Peru’s economy to match that expansion this year.

“Growth of the Peruvian economy has stabilized close to its long-term sustainable level even though indictors linked to the external market still show a weak performance,” policy makers said in their statement.

Peru’s economy, as measured by the national statistics agency’s economic activity index, grew at an annual rate of 6.2 percent in January and will approach that level in February, Velarde said. The economy can expand 6.4 percent without stirring demand pressures, he said.

“Of course, we will look at other things to see if we’re going to be somewhat more restricted or somewhat more relaxed,” Velarde said.

Export Decline

Falling exports haven’t dented growth in the third-largest copper and zinc producer. Exports fell 22 percent in February, after metal shipments declined. Increased Chinese demand should bolster Peru’s exports in the second quarter, according to Rios.

The yield on Peru’s benchmark 7.84 percent sol-denominated bond due August 2020 has fallen 14 basis points, or 0.14 percentage point, to 3.74 percent this year. The Lima General Index has dropped 5.7 percent.

A record $12.2 billion in foreign direct investment and demand for local government bonds poured dollars into Peru’s $200 billion economy last year, leading to a 5.7 percent appreciation in the sol.

The central bank may try to ease the pace of speculative inflows by cutting the overnight rate as inflation expectations decline in the second half of this year, said Jose Martinez, head of investments at Rimac Seguros y Reaseguros, Peru’s largest insurer.

Output Growth

Peruvian consumer prices surprised economists by climbing 0.91 percent last month, the biggest jump in five years, after a surge in food, transport and schooling costs. The annual inflation rate rose to 2.59 percent from 2.45 percent, remaining within policy makers’ target range of 2 percent plus or minus 1 percentage point.

Prices in April will probably rise less than the 0.53 percent increase seen in the same month a year ago, leading to a slower annual inflation rate, Velarde said.

The central bank forecast inflation will converge to the center of its target range “in the coming months” as food supply improves, amid economic growth that’s near potential and a weak global market.

According to a central bank survey published March 12, economists expect 2.5 percent inflation this year, above policy makers’ forecast of 2 percent.

“External factors have been driving inflation in the last few years and the pressure isn’t going to be as great this year,” said Martinez in an April 3 interview in Lima. “The consumer boom isn’t generating inflation pressures because output is seeing considerable growth too.”

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