Central Bank of Costa Rica Cuts Interest Rates 

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By LatAm Reports Staff Writers

The Board of Directors of the Central Bank of Costa Rica (BCCR), in session of January 18, 2024, agreed to reduce the Monetary Policy Rate (TPM) by 25 base points (p.b.) to place it at 5.75% per year from January 19, 2024.

The Central Bank of Costa Rica conducts its monetary policy on the basis of an inflation target scheme. In this context, monetary policy is forward-looking and uses the Monetary Policy Rate as the main instrument for establishing its policy position.

To decide on the level of the MPC, the BCCR assesses the recent behaviour and trajectory of inflation forecasts and its macroeconomic determinants.

The decision also considers the analysis of the economic situation, as well as the risks it identifies, whether internal or external, and whose materialization would divert inflation from its central projection.

These were the considerations used by the BCCR Board of Directors to reduce the level of the MPC:

  1. Article 2 of the Organic Law of the Central Bank of Costa Rica provides as part of its main objectives to maintain the internal stability of the national currency; that is, to ensure low and stable inflation. Price stability protects the purchasing power of the colon, reduces transaction, information and coordination costs and also facilitates economic calculation by households and businesses. These conditions promote the efficient allocation of resources in the economy and macroeconomic stability; this has a positive impact on economic growth, job creation and, in general, the well-being of the population.
  2. In the international context, the slowdown in inflation continues and, in some countries, is close to the target of their central banks. While inflation has fallen, this process has taken longer than initially anticipated, so central banks generally maintain the restrictive tone of monetary policy. In advanced economies, the benchmark interest rate has been held at recent policy meetings; in some such as the US economy, they have pointed out that they value a gradual reduction and around 75 basis points (p.b.) in the course of 2024, but others indicate that they will do so until the reduction of inflation is sustained. In Latin America, the process of reducing the reference interest rate of several central banks is notorious, including the Costa Rican case, which was the first central bank in the region to reduce this indicator in 2023; specifically the cumulative reduction was 300 dc, to reach 6.0% per year at the end of the year.
  3. At the national level, economic growth has been robust, driven by both the production of companies in the definitive regime and the special regimes of the Monthly Index of Economic Activity grew at an annual rate of 5.3 per cent and at an average rate of 5.6 per cent last November; however, in recent months this rate has moderated. Labour market indicators, for their part, continue to have improvements in formal employment and real wages, and unemployment and underemployment rates are again declining, although the labour participation rate also decreases due to a variety of social, economic and demographic factors. In the moving quarter ended in November, unemployment and underemployment rates stood at 7.2% and 4.3%, lower by 4.4 and 5.8 percentage points (p.p.) to the same month in 2022, while real wages increased 6.4 per cent in year-on-year terms, although for some labour market groups its level remains below the pre-demops pandemic.
  4. In December 2023, the year-on-year indicator of general inflation was negative for seventh consecutive month, while the average of underlying inflation indicators continues at positive but low, so both are below the tolerance range around the inflation target (3.0% – 1 p.p.). Specifically, at the end of 2023 the year-on-year variation in the Consumer Price Index was -1.8% and the average of the underlying inflation indicators was 0.2%.
  5. The trajectory of general inflation in the last seven months (deflation) has been determined by the evolution of the prices of goods, in particular food and the above, is consistent with the dissipation of external supply shocks, where the reduction in commodity prices stands out. Added to these factors are elements of an internal nature such as restrictive monetary policy and appreciation of the local currency. The reversal of the external supply shocks also influenced the Price Index of the Manufacturer Producer, whose year-on-year variation was -5.7% in December. This translates into lower cost-cutting pressure on inflation indicators to the final consumer.
  6. Inflationary expectations are within the defined tolerance range for inflation. The inflation expectations obtained by the BCCR through the survey are 2.0% and 3.0% (medium) for the horizons of 12 and 24 months, respectively, while those estimated from the negotiation of public securities in the Costa Rican (market) financial market recorded values of 2.4% and 2.6% for these deadlines.
  7. The Central Bank’s projections indicate that the disinflationary shock will have a greater persistence than estimated These projections, in its central scenario, contemplate negative inflation in the first quarter of the year and a return to the tolerance range towards the end of 2024.
  8. The presence of external and local risks, some of them renewed and increased, the materialization of which could divert inflation from the projected path, deserves to be maintained with regard to changes in the MPC, even though the information available indicates that there is room to reduce this reference. Of the risks up to the rise stand out: (a) Those related to supply shocks and the fragmentation of global trade, due to climatic phenomena and geopolitical conflicts; the latter aggravated by tensions in the Middle East, particularly in the Red Sea. The price of maritime transport services has increased, which provides for a negative impact on global supply chains and therefore threatens new upward pressures on the prices of some goods and services. (b) Domestically, an eventual recomposition of the portfolio of financial instruments is not ruled out, which could increase expectations of exchange rate variation and therefore inflation expectations, especially in a context of excess liquidity that have so far been managed in the money market. The Board of Directors also identifies downward risks, among others, associated with economic growth of our main trading partners lower than that envisaged in the estimates analyzed. Uncertainty about global economic performance is greater given the intensification of geopolitical tensions (e.g. in the Middle East, Africa and Europe) and a restrictive monetary policy that has lasted longer than expected.
  9. Based on the analysis of the recent and expected behaviour of inflation and its macroeconomic determinants, the assessment of risks and the lag with which monetary policy acts, the Board of Directors will continue the path towards monetary policy neutrality in the medium term, provided that circumstances permit.
  10. Changes in PMs need to be gradual and prudent, so that it is possible to react in a timely manner and in the appropriate direction, if macroeconomic conditions and risk assessment so require.

This article has been translated from the original which first appeared in El Mundo