Peru Keeps 3.25% Rate as Sol Weakness Poses Threat to CPI

Peru kept borrowing costs unchanged at a four-year low as policy makers gauge prospects for a rebound in growth after unexpectedly cutting rates last month.

The central bank board, led by President Julio Velarde, kept the overnight rate at 3.25 percent, as forecast by 18 of 20 economists surveyed by Bloomberg. Two expected a cut to 3 percent. The bank highlighted increased currency volatility, mixed global economic data and below-potential growth in Peru’s economy among reasons for its pause.

“Activity indicators continue to show a weak economic cycle,” policy makers said in their statement accompanying the decision. The board is ready “to consider additional easing measures if needed,” it added.

Policy makers lowered the rate by a quarter-point last month after the economy expanded at its slowest pace in five years in 2014 amid a slump in exports from the world’s third-largest copper producer. While weak growth gives policy makers grounds for further easing, a rate reduction would risk fueling inflation that’s been above target for 11 of the last 13 months, said Francisco Rodriguez, an economist at Bank of America Corp.

“The board is worried about the inflationary pass through and the sol depreciation that would continue if they’re more aggressive in lowering rates,” Rodriguez said by phone from New York. “They’re looking at the evidence to see if there is a risk of going into recession and trying to move somewhat slowly because of the risk of inflationary pass through.”

Currency, Inflation

Peru’s sol is trading at its weakest in close to six years after exports fell 9.3 percent in 2014, leaving a record trade deficit of $2.55 billion.

The sol has dropped 8.2 percent against the U.S. dollar in the last year, increasing the cost of imports and making it more expensive for Peruvians to pay back U.S. dollar loans using local currency. The sol has weakened 2.2 percent since the board’s Jan. 15 meeting.

While Peru’s annual inflation rate eased to 3.07 percent last month from 3.22 percent in December, it remains above the central bank’s target of 1 percent to 3 percent.

The central bank introduced curbs on lenders’ trading on currency derivatives last month as it seeks to contain sol volatility. The measures gave policy makers room to lower rates last month, Velarde told reporters Jan. 23.

Inflation will slow to about 2 percent this year as fuel prices decline and the economy expands at a rate below its potential, he said.

‘Slacker Demand’

Reduced output at Peru’s biggest copper mine, tighter rules on gold exports and smaller fishing catches have compounded the slowdown in South America’s fastest growing economy of the past decade.

The monetary authority lowered the reserve requirement ratio in soles Feb. 1 for the 10th time in the last year.

“Peru’s real business cycle remains dormant, undermined by the prolonged slowdown in investment spending,” Tiago Severo, an economist at Goldman Sachs Group Inc., wrote in a Feb. 10 e-mailed note to clients. Severo forecast a cut at today’s meeting though he said currency pressures could lead the board to delay the move.

Peru’s Finance Ministry and the central bank both expect growth to rebound to 4.8 percent in 2015 on higher public investment, infrastructure projects and copper output.

Weaker consumer demand and stagnation in private investment this year will limit Peru’s economic growth to 3 percent, according to Bank of America’s Rodriguez.

“Lower price pressures combined with the slacker demand that comes from poor economic growth may give the central bank reason to” cut rates further this year, he said.

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