Peru Keeps 3.5% Rate After Currency Declines to Five-Year Low

Peru kept borrowing costs unchanged after the sol fell to its weakest level since 2009 following slower-than-expected growth and interest rate cuts at two of its previous four meetings.

The six-member central bank board led by President Julio Velarde maintained the overnight rate at 3.5 percent yesterday, as forecast by 15 of 19 economists surveyed by Bloomberg. Four analysts had expected a quarter-point reduction.

Indicators “continue to show a weak economic cycle, with GDP growing at rates below its potential,” the central bank said in a statement accompanying the decision. The bank cited mixed signs of recovery in the world economy and increased volatility in the currency markets among the reasons for its decision to pause.

Policy makers lowered the key rate by a quarter point in in July and again in September as the economy struggles to regain momentum amid a slump in copper and gold exports. While the economy needs additional fiscal and monetary stimulus, lowering rates risks deepening a slide in the sol, said Hugo Perea, the chief economist at BBVA Banco Continental.

“The macroeconomic context is difficult,” Perea said by phone from Lima. “The currency likely will depreciate in the coming months, but the central bank will want to make sure the process is gradual and give the private sector time to adjust.”

Inflation Accelerates

The monetary authority has sold $3.4 billion of the U.S. currency this year to bolster the sol as the Federal Reserve’s move toward raising interest rates fuels a surge in the dollar.

The intervention has removed about 10 billion in soles from circulation, leading the central bank to cut the reserve requirement ratio to sustain bank lending in local currency. The bank has lowered the ratio eight times this year, including a cut this month, freeing up 10.7 billion soles, according to a Nov. 2 statement.

While the weakening sol will help Peru reduce its current account deficit by making non-commodity exports more competitive and slowing imports, a rapid depreciation risks hurting investor and consumer sentiment in an economy where about 45 percent of loans are in dollars, Perea said.

The sol’s 13 percent depreciation since April last year, follows four consecutive years of gains.

The weaker currency is pushing up imports costs, fueling inflation that accelerated to 3.09 percent last month from 2.74 percent in September, breaching the central bank’s target range for the first time in three months.

The central bank, which targets inflation in a range of 1 percent to 3 percent, sees price growth slowing to 2 percent next year, Velarde said Oct. 22.

Stimulating Growth

Concerns about currency depreciation worsening may lead policy makers to lean more on expansive fiscal policy, said Francisco Rodriguez, an economist at Bank of America.

Peru’s government last week approved one-time bonuses totaling almost 1 billion soles ($341 million) for public sector workers and the poor to boost demand, in the third round of fiscal stimulus this year. It also approved 600 million soles in spending on school and sanitation projects and permitting measures to speed up mining and hydrocarbon investments, Finance Minister Alonso Segura said Nov. 6.

“The more authorities defend an exchange rate objective, the less room they have to react to the external shock with expansionary monetary policy,” Rodriguez wrote in a Nov. 6 note to clients.

Previous stimulus efforts have failed to spur public investment, which fell 1 percent in October from a year ago, according to the Finance Ministry.

In its quarterly inflation report last month, the central bank cut its growth forecast for 2014 to 3.1 percent, the slowest pace since 2009 and down from an April estimate of 5.5 percent. It also lowered its view for 2015’s expansion to 5.5 percent from 6.7 percent.

The price of copper, Peru’s top export earner, has dropped 12 percent in New York this year, damping mining outlays in the third-largest producer of the metal. Gold has dropped 3.3 percent.

“I wouldn’t rule out a cut in rates next month,” Perea said. “Fiscal policy has gone in the right direction, but the implementation has had problems so what’s left but to add more monetary stimulus.”

Before it's here, it's on the Bloomberg Terminal.