By Palash R. Ghosh | August 9, 2010 9:36 AM EDT
Peru hikes interest rates again; central bank seeks to tame inflation amidst "spectacular' economic growth
For a second time this year, the central bank of Peru surprised markets by raising its benchmark lending rate – by 50 basis points, more than economists forecast -- to 2.5 percent.
The move was described by Julio Velarde, the chief of Banco Central de Reserva del Perú (Central Reserves Bank of Peru) as a measure to head off inflationary pressures arising from “spectacular” economic growth.
Peruvian rates have now been raised by a total of 125 basis points, from 1.25 percent to 2.5 percent, in just three months. Central bankers in Brazil and Chile have also raised lending rates so far in 2010.
Juan Pablo Fuentes, chief economist at Moody’s Economy.com, was quoted as saying that Peruvian economy is expanding at a “very robust pace” due to strengthening domestic demand.
Indeed, Peru and Brazil are believed to be the fastest-growing economies in South America.
Peru's economy (South America's sixth-largest) grew by only 0.9 percent last year – the slowest advance since 2001. However, in May of this year, the economy surged by 9.2 percent on a year-over-year basis, fueled by skyrocketing private demand. Velarde said the GDP may show 10 percent growth for the June year-over-year period.
The country's annual inflation rate has climbed to 1.82 percent in July – an 11-month high – from just 0.25 percent last December. The central bank said in June that it expects the inflation rate to rise to 2.0 to 2.5 percent by the end of the year (still the lowest among major Latin American countries).
The central bank targets inflation at between 1 percent to 3 percent.
Neal Shearing, senior emerging markets economist at Capital Economics in London, believes interest rates in Peru could reach 3.5 percent by year-end.
“The economy is certainly experiencing a strong V-shaped recovery,” he said.
“With GDP on track to expand by 7.5 percent this [full] year, it is clear that the economy no longer needs the support of ultra-loose monetary policy.”
Shearing adds however that economic growth in Peru is likely to fade over the next 18 months, “on the back of a faltering global
recovery and lower commodity prices.”
The problem for policymakers, Shearing asserts, is that raising interest rates risks attracting additional capital inflows, thus putting further upward pressure on the nation's currency, the sol.
Indeed, Peru's currency, the sol, has soared about 16 percent since its March 2009 lows as the economy rebounded.
“The [Peruvian] currency... is closing in on its pre-crisis high of 2.70/$US,” Shearing explained.
“Accordingly, the economy is increasingly at risk of the so-called ‘Dutch Disease’, whereby commodity-related currency appreciation starts to squeeze the non-commodity sector, in which productivity growth and employment are typically higher.”
Policymakers will have to tread a careful line between cooling growth in the real economy on the one hand and stoking excessive currency appreciation on the other, he added.
Peru hikes interest rates again; central bank seeks to tame inflation amidst "spectacular' economic growth
For a second time this year, the central bank of Peru surprised markets by raising its benchmark lending rate – by 50 basis points, more than economists forecast -- to 2.5 percent.
The move was described by Julio Velarde, the chief of Banco Central de Reserva del Perú (Central Reserves Bank of Peru) as a measure to head off inflationary pressures arising from “spectacular” economic growth.
Peruvian rates have now been raised by a total of 125 basis points, from 1.25 percent to 2.5 percent, in just three months. Central bankers in Brazil and Chile have also raised lending rates so far in 2010.
Juan Pablo Fuentes, chief economist at Moody’s Economy.com, was quoted as saying that Peruvian economy is expanding at a “very robust pace” due to strengthening domestic demand.
Indeed, Peru and Brazil are believed to be the fastest-growing economies in South America.
Peru's economy (South America's sixth-largest) grew by only 0.9 percent last year – the slowest advance since 2001. However, in May of this year, the economy surged by 9.2 percent on a year-over-year basis, fueled by skyrocketing private demand. Velarde said the GDP may show 10 percent growth for the June year-over-year period.
The country's annual inflation rate has climbed to 1.82 percent in July – an 11-month high – from just 0.25 percent last December. The central bank said in June that it expects the inflation rate to rise to 2.0 to 2.5 percent by the end of the year (still the lowest among major Latin American countries).
The central bank targets inflation at between 1 percent to 3 percent.
Neal Shearing, senior emerging markets economist at Capital Economics in London, believes interest rates in Peru could reach 3.5 percent by year-end.
“The economy is certainly experiencing a strong V-shaped recovery,” he said.
“With GDP on track to expand by 7.5 percent this [full] year, it is clear that the economy no longer needs the support of ultra-loose monetary policy.”
Shearing adds however that economic growth in Peru is likely to fade over the next 18 months, “on the back of a faltering global
recovery and lower commodity prices.”
The problem for policymakers, Shearing asserts, is that raising interest rates risks attracting additional capital inflows, thus putting further upward pressure on the nation's currency, the sol.
Indeed, Peru's currency, the sol, has soared about 16 percent since its March 2009 lows as the economy rebounded.
“The [Peruvian] currency... is closing in on its pre-crisis high of 2.70/$US,” Shearing explained.
“Accordingly, the economy is increasingly at risk of the so-called ‘Dutch Disease’, whereby commodity-related currency appreciation starts to squeeze the non-commodity sector, in which productivity growth and employment are typically higher.”
Policymakers will have to tread a careful line between cooling growth in the real economy on the one hand and stoking excessive currency appreciation on the other, he added.