Sticky services inflation, core inflation expectations that have halted their decline and global financial conditions that have unfolded less favorably for emerging economies have led us to believe the Board will continue with the 50bp rate cut pace to 9.75% at its meeting on October 31. We initially believed that an aggressive start to the Fed’s cutting cycle would alleviate global financial conditions and provide space for a larger 75bp cut already in October. In September, the Board was split 4-3 in favor of a 50bp cut. The minority backed 75bps. The minutes showed that the majority supporting the steady -50bp pace believed that a larger cut could jeopardize the inflation convergence path and the continuity of the cycle that has so far boosted economic growth forecasts closer to potential GDP in both 2025 and 2026. Factors supporting the cautious stance included: 1) the persistence of elevated and sticky core services inflation; 2) the uncertainty surrounding the minimum wage adjustment in 2025; 3) the rigidity of inflation expectations; and 4) a challenging fiscal scenario.
In the run-up to the October meeting we do not believe there has been significant relief to such concerns to warrant a larger cut. Regarding inflation expectations, headline expectations ticked down marginally across different horizons but remain far from the 3% target. Meanwhile core inflation expectations for 2024 and 2025 stagnated at 5.7% and 3.7% respectively, and the one-year ahead outlook rose 8 bps to 4.0%.
On the external front, the Fed's dovish pivot was not as benign as expected for external financial conditions. The proximity to the US presidential election, and stronger-than-expected activity indicators pushed the 10-year US Treasury note returns to above 4% and the local exchange rate rebound above the 4,300 (3.3% depreciation from the September meeting).
While the dovish camp justified its -75pb vote on the grounds of a cooling labor market, the unemployment rate (SA) remained stable from the previous month at 10%. We believe this is not a strong enough factor to persuade a further board member to break from the majority group. Indeed, the August national unemployment rate remained below the estimated NAIRU by BanRep’s technical staff.
Activity has shown signs of recovery. Retail sales have accumulated a semester of sequential expansions and rising 5.2% YoY in August. Due to consumption the coincident ISE accumulated two upside surprises in the quarter with expansions of 3.8% and 2.0% YoY in July and August. On balance, a less negative output gap than previously forecasted may slow the disinflation path going forward.
Consumer price pressures surprised to the downside in 3Q, with inflation dropping 137bps from the June CPI to 5.81% YoY, the lowest level since 2021. Nevertheless the ex-food metric adjusted more slowly (6.55%). Not surprisingly, disinflation in core services has slowed, rising 3bps since the September meeting to 7.48% YoY. Specifically, the CPI for rents remains well above target (7.90%YoY vs. 7.93% at the previous print), as do other services such as hotels & restaurants (9.08%YoY vs. 8.8%YoY in August) and education (10.62%YoY). On balance, while the disinflation process continued in September, the inflation mix worsened. With indexation mechanisms prominent in the Colombian economy, the Board will be keeping an eye on the magnitude of the 2025 minimum wage adjustment. A revision above 7% could be deemed detrimental to the CPI convergence path.
Recent surveys show division with 54% of analysts surveyed by BanRep favoring a larger 75bp cut, while asset prices are more inclined to continue with the 50bp pace. Colombia's one-year ex-ante real rate currently stands at 6.2%, the third highest in the region, and is expected to fall further to 3.50% over the next 12 months. Given the more benign inflation dynamics in peer countries and the more contractionary monetary stance in some cases, such as Brazil (with a real rate of 6.71%, which is now reversing its easing process), an acceleration in the pace of domestic rate cuts would likely increase pressure on the COP.
Our take: We do not believe macro indicators have evolved in a way that would convince another Board member to vote for a larger cut. We expect a 50bp cut to 9.75%. Global uncertainty, sticky domestic core inflation pressures, elevated inflation expectations and improving activity dynamics support the continuance of a cautious cycle. We expect BanRep to wait for more clarity on the upside risks to inflation, possibly addressed in the October Monetary Policy Report to be released on November 5th. The impact of the labor reform and low reservoir levels on electricity tariffs could be risks analyzed in the document. Additionally, awaiting greater clarity on the 2025 minimum wage adjustment and a calmer external environment after the US elections also favor caution in the short-term. The minutes of the meeting will be published on November 6th.
