Peru’s central bank tightens again as inflation surges

The Central Reserve Bank of Peru (BCRP) increased interest rates after its policy meeting on April 7, in its ninth consecutive hike since August.

The BCRP’s board of directors hiked the reference rate by 50 basis points to 4.5%. In August 2021, it started increasing rates from a record low 0.25%, but inflation has continued increasing over the target.

In March year-on-year headline inflation rose to 6.8%, up from 6.15% in February. The central bank’s inflation target is a band from 1% to 3%. Core inflation increased last month by 3.46%, up from 3.26% in February.

The central bank’s policy statement increased its one-year-ahead inflation forecast from 3.75% to 4.39%. This was the first statement from the board that did not describe higher inflation as temporary.

Rising fuel and food prices are helping drive inflation and have triggered protests across the country in recent weeks. Demonstrators have blocked roads, demanding an intervention from the government.

The Russian invasion of Ukraine has contributed to increase key commodity prices, including oil, gas and wheat. Peru tends to benefit from higher commodity prices, because it is the world’s second-largest copper producer after Chile. However, the energy shock is hitting the economy at a time when the central bank was already facing rising inflation.

The board again delayed its forecast for when inflation will return to the target to the second quarter of 2023. In its previous policy assessment in March it expected inflation to decline to target in the first half of 2023, and in February to do it in the fourth quarter of 2022.

The BCRP now says it expects inflation to peak in July this year. After that it anticipates that the exchange rate, international fuel prices and grain prices will have a weaker effect on inflation. It also predicts economic activity will still be below its potential level

“We have revised our inflation estimate for this year from 3.4% to 5.0% and for the next from 2.3% to 2.6% as a result of the impact of the conflict between Russia and Ukraine on international prices of oil and some grains and cereals,” says Hugo Vega, senior economist with BBVA bank. “In our current base case, we consider that these prices will remain at higher levels for longer, generating a prolonged impact on domestic inflation.”

Vega says Peru’s inflation outlook is becoming challenging. He warns the increase in year-on-year inflation expectations “is worrisome”, especially in a context where “inflation has not yet reached its peak, and higher inflation expectations imply a less restrictive monetary policy position in real terms”. This month the nominal rate is 50bp higher, but the BCRP increased inflation expectations by 64bp from 3.75% to 4.39%.

“We anticipate that expectations of price increases will be affected by this evolution, generating second-round effects on inflation,” says Vega. “In our baseline scenario we believe that the BCRP will opt to continue adjusting its monetary policy rate to contain an even greater disanchoring of inflationary expectations, raising it to 5.5% in the third quarter of this year.”