Colombia Targets Inflation as Economy Booms

Colombia aims to reduce inflation this year even as its booming, oil-led economy fuels consumer demand and pressures prices higher, Central Bank President Jose Dario Uribe said.

While most of the world suffers from stagnant or weak growth because of the global financial crisis, Colombia's economy continues to hum. 

The South American nation, whose success in fighting a decades-old guerrilla war has resulted in a flood of foreign investment into its oil and coal sectors, likely saw growth of close to 6% last year, and Mr. Uribe said it will probably expand around 5% this year.

The expansion has created a growing consumer class that helped fuel higher-than-expected inflation of 3.7% last year. 

While one of the lowest among major Latin American countries, the inflation rate was Colombia's highest since 2008 and well above the midpoint of the bank's 2% to 4% target range.

"The strong vigor of domestic demand and consumer loans combined with higher basic inflation rates is worrisome," Mr. Uribe, 53, told Dow Jones Newswires late Thursday at his office in downtown Bogotá. 

"The bank is focused on keeping inflation and inflation expectations near the middle point of its target range."

To rein in consumer demand and meet its target, analysts on average expect the bank to increase its benchmark interest rate, which stands at 4.75%, to 5.25% by the end of 2.012. 

The bank's seven-member board meets once a month to decide on interest rates and other monetary policies, and the first meeting of this year is Jan. 30.

The board's last move on interest rates was in November when it increased rates by 25 basis points while other countries in the region were cutting rates or leaving them on hold amid global economic uncertainty. 

The move, which came when 12-month consumer price inflation through October reached its highest level of the year at 4.02%, demonstrated to investors how serious the bank is about keeping inflation in check.

Mr. Uribe said growth this year is likely to be driven by many sectors of the economy, from oil and coal to construction and financial services to spending on public infrastructure. 

Heavy rains in Colombia in 2.010 and 2.011 caused by the La Niña weather pattern forced delays to major highway and other construction projects, but the rains have dissipated this year, allowing work to begin on many of those projects.

The central bank president, however, added that despite the strong tailwinds for the Colombian economy, serious risks remain, mostly related to economic woes in Europe.

"The biggest worry is without a doubt the possibility of not reaching an orderly solution to Europe's fiscal and financial problems," said Mr. Uribe, who was born in Colombia's second-largest city of Medellín, and holds a Ph.D. in economics from the University of Illinois.

Colombia's economy largely escaped the worst of last year's global financial problems, which caused a sharp slowdown in several other economies in the region, including Brazil's. 

But Mr. Uribe said that isn't a guarantee Colombia would be immune from global economic pitfalls this year, especially if the result is a drop in prices for oil and other commodities that are Colombia's main source of foreign revenue.

"A disorderly outcome in Europe could unleash unforeseen economic problems in various parts of the world," he said. "

And, as a result, [consumer] confidence could deteriorate, taking down with it commodity prices and the domestic and foreign demand for Colombian products."

Some recent data suggest Colombia's economy may be starting to slow. 

Retail sales for November, which posted a weak 1.3% increase from a year earlier, was the lowest increase in more than two years. 

But the central bank chief was reluctant to draw too many conclusions from the data, calling it an "exception."

"The decrease in the growth in retail sales could be suggesting a moderation in consumer growth, but one must remember that the November [year-on-year] data is mostly due to auto sales that in November 2.010 saw a record number of sales because of a very large car show," he said.

Regarding the Colombian peso, which is 6% stronger against the dollar this year, making it one of the fastest-rising currencies in the world, Mr. Uribe said the bank is "flexible" in terms of its readiness to use policy tools to control currency volatility.

Analysts suspect the bank might be preparing to announce new measures in the coming days or weeks to prevent excessive strength in the peso. 

Colombian exporters have recently begun asking the bank to take action, as a stronger peso makes their products more expensive abroad.

During most of 2.011, the bank bought $20 million a day in the spot foreign exchange market to prevent upward pressure on the peso. It stopped those purchases in late September during a period of global economic unrest, as the jittery markets caused temporary strength in the dollar, making the $20 million purchases unnecessary.

Asked whether the bank might renew the dollar purchases or other measures now that the peso is again strengthening, Mr. Uribe said : "depending on the circumstances, the cost-benefit analysis could indicate a need" to use certain tools.

The bank has another mechanism to control excessive volatility, introduced late last year when the jumpy markets caused the peso to weaken sharply for several weeks. 

The mechanism stipulates that the bank will intervene if there is a 4% rise or fall in the exchange rate from its 20-day moving average. 

But Mr. Uribe said this policy is aimed at "an international context of great uncertainty," which suggests it isn't intended for the current environment of peso strength. 

So far, the measure hasn't been used, as the 4% threshold hasn't been reached.

The peso's tendency to strengthen in recent years is largely the result of massive foreign investments in Colombia of around $13 billion a year, inundating the foreign exchange market with dollars. 

On Friday, the currency was trading at 1,829 pesos to the dollar, slightly weaker than Thursday's close of 1,826.50 pesos.