Central Bank Preview: Tightening Continues

Research evidence excerpt

Central Bank Preview: Tightening Continues

IdeaMembedded in TES markets, the ex-ante real rate rose to around 5.5% in June, its

highest level this year. At first glance, this suggests that monetary conditions have

tightened materially even without additional policy action. However, the

improvement has been driven almost entirely by the market-implied component.

The real rate implied by one-year breakevens increased from 4.4% in May to 5.1% in

June. In our view, this primarily reflects a compression in inflation compensation

following De la Espriella’s June 21 victory, rather than a meaningful improvement in

underlying inflation expectations. Moreover, year-end ex-ante real rates remain

around 4.77%, still below the upper end of our estimated neutral range of roughly

5.2%. BanRep would therefore need to tighten by at least 75bp to move the policy

stance clearly above that threshold.

In addition, the inflationary effects of El Niño still need to be incorporated into the

policy outlook. We estimate that these effects could require an additional 80–90bp

of policy tightening if they materialize as expected. For that reason, we expect

BanRep to deliver a 75bp hike in June, followed by two 25bp hikes, taking the

terminal rate to 12.50% ( Exhibit 2 ). This would still represent a milder tightening

cycle than we had initially anticipated, reflecting the improved political and fiscal

outlook, but not enough to eliminate the need for additional monetary restraint.

Strategy implications: Going into the meeting, market pricing remains split

between a 50bp hike at the June meeting versus a 75bp hike, with implied terminal

rate level at ~12.50% by year-end. We note that the IBR curve also embeds ~225bp

of subsequent easing into YE29, towards 10.25%.