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SocGen: Risk Is Tilted Towards Sharper Tightening, Possibly By 150BP

COLOMBIA
  • There are several problems with the central bank’s return to a dovish approach. To begin with, the economy is clearly overheating and looks set to grow at over twice its potential in 2022 too. This overheating has created sharp external sector imbalances that are putting pressure on the currency, which was already under pressure due to high imports and the tightening in global financial conditions.
  • However, the recent discussions in the Petro administration on issuing debt to buy land for the poor and introducing capital control measures to check outflows have really jolted the bond market, leading to a further sharp decline in the peso. This is bound to create further challenges for financial/fiscal stability and worsen the inflation outlook too.
  • Both headline and core inflation increased further in September, making it difficult to predict if the disinflation process will begin this year or not. In the past two cycles, BanRep has not necessarily chased inflation all the way when it needed to support the economy.
  • Nevertheless, things are different this time, with demand well above potential. The policymakers have ruled out using FX reserves to support the currency. While we expect BanRep to lift rates by another 100bp (to 11.0%) in October, the risk is tilted towards sharper tightening (possibly by 150bp).
  • The central bank will most likely leave the door open for additional adjustments in December (and beyond, particularly if inflation continues to surprise on the upside over the next two months). If the pressure on the currency worsens again, the possibility of sharper tightening, even between meetings, cannot be ruled out either.
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