All the market forecasts estimate that as of April, inflation will begin to loosen and begin to drop slowly. However, a threat appears on the horizon that could complicate this situation.
An analysis carried out by Felipe Klein, Economist for Colombia and Chile at BNP Paribas on inflation in Colombia, highlights as positive that inflation has probably peaked and its expectations are stabilizing given the recent appreciation of the exchange rate and some fiscal and more moderate policies.
However, it says that “we are revising our inflation forecast for the end of 2023 upwards by 1 percentage point, to 9.5%, due to the persistence of underlying inflation, this because with the appearance of the El Niño phenomenon, the risks are biased upwards, given the high probability that it will develop between this month and July 2023”.
Klein indicates that “contrary to the consensus, we do not expect rate cuts in 2023. We believe that one-year inflation expectations will probably remain well above target until the end of the year.”
He maintains that inflation is going to present a long plateau. “In our view, annual inflation is likely to decline in the coming months from the current 13.3% due to base effects.”
Persistence
Inflation is likely to remain above 10% through November due to the persistence of core inflation. The three-month seasonally adjusted annualized core inflation rate is above 13%, suggesting that the upward trend in core inflation could continue despite the headline peaking in March.
Driven by services inflation of 10%, core inflation will probably reach 9.5% per year by the end of 2023 (0.8 percentage points above the Banco de la República forecast).
On the other hand, indexation and inflation expectations above the target will maintain pressure on the prices of non-tradable goods, especially rentals. Goods prices (excluding food and energy) will likely experience some disinflation relative to services, ending 2023 with 8.5% year-on-year growth, given recent currency appreciation.
“However, we think that a still positive output gap (currently at 2-3%) through Q3 2023 and above-target inflation expectations likely mean this shock could take time to materialise.”
Regarding the limited incidence of exchange rate appreciation, he says that “we found evidence of asymmetric effects in the transmission of the exchange rate in Colombia. Although the linear is between 7% and 10%, we estimate that depreciations will be transmitted to a greater extent (14% after one year) to domestic prices than appreciations (5% after one year). In addition, we think that companies could initially take advantage of a stronger peso to rebuild profit margins after the various shocks that raised costs last year.
Gaps
Likewise, the technical staff of the Banco de la República estimated a positive inflation gap of the real exchange rate of 10% for the first quarter of 2023. Positive values imply upward pressure from the exchange rate on inflation, which which suggests that the pass-through of the latest depreciation is still incomplete.
The expert points out that “we revised the inflation forecast for the end of 2024 to 5%: The indexation to higher inflation at the end of 2023 explains the change of 0.5 percentage points with respect to our previous forecast, partially mitigated by a gap of negative production throughout 2024”.
The El Niño phenomenon poses upside risks to monetary policy. According to the Climate Prediction Center (CPC), there is a 62% chance that the El Niño phenomenon will develop between May and July 2023 and more than 80% that it will happen during the second half of the year.
Certainly with the adverse weather conditions stemming from El Niño, food prices should increase. Although the impact varies depending on the intensity of the phenomenon, the high probability that it will occur in the second half of 2023 calls into question the Issuer’s prospects of a downward trend in inflation during the period, mainly based on a rapid decline in food prices.
The Bank’s reference scenario is that food inflation will end 2023 at 5.7% year-on-year. This would require it to be at 0% from May to December, which seems unlikely given the imminent El Niño risks. The mere expectation that the event will materialize can affect the investment decisions of agricultural producers, reducing supply and causing prices to rise.
Foods
“According to various studies by Banco de la República, food inflation can increase between 100 points and 400 points five months after the event, depending on the intensity of the disturbance (the probability of a strong event is 40%, according to the CPC). Overall, we believe that the probability of another supply shock for inflation in Colombia is greater than 50%, which would interrupt the timid decline in inflation expectations (food represents 15% of the CPI basket),” he says. the expert.
On the other hand, the researcher says that there is a low probability of a drop in interest in 2023: “the consensus of analysts is that the BanRep will lower the official interest rate by 175 points in 2023, we do not expect rate cuts this year. While inflation expectations one year ahead fell 70 points from January to 7%, the consensus for the end of 2023 increased 70 bp to 9.3%.
He maintains that “we believe that this may be pointing to an inconsistency, given the high degree of indexation of Colombian inflation, which is mainly concentrated in the first quarter. Our one-year inflation forecast remains at 40 basis points above consensus. The difference will end up translating into a slow convergence of inflation expectations that will delay the easing cycle until 2024. We believe that the imminent risks of El Niño could cause a change in consensus”.
The other vision of the IPC
The latest Financial Opinion Survey (EOF), prepared by Fedesarrollo and the Colombian Stock Exchange, showed how the main market analysts expect inflation to finally subside in April, and also that the last rise in interest rates will take place. .
According to the EOF, after the data of 13.34% registered by the annual variation of the Consumer Price Index (CPI) in March, analysts consider that inflation will be located at 12.96%, in a range between 12 .9% and 13.0%.
Looking at the end of the year, market expectations suggest that by December 2023 inflation will be at 9.12%, which implies an increase compared to the forecasts made in the previous edition of the EOF (9, 0%).
Hand in hand with this reduction in the price indicator, experts expect that in the second half of the year the interest rate of the Banco de la República will also fall and stand at 11% at the end of the year, while for 2024 they project that drop to 9.0%.
Regarding growth forecasts for 2023, in the April survey the GDP forecast was in a range between 0.7% and 1.2%, with 1.0% as the average response, while for next year the GDP projection stood at 2.3%, with a range between 1.8% and 2.7%.
In addition, the survey revealed that expectations for growth in the first quarter of 2023 were in a range between 2.0% and 2.5%, with 2.1% as the average response, while in the March edition of the survey was at 2.0%.
On the other hand, the growth forecast for the second quarter of 2023 was 0.9%.