Colombian Peso Strength Fails to Deliver Expected Inflation Relief

The Colombian peso has appreciated by nearly 20% since the start of the year, closing at 3,084.9 pesos per US dollar in August. According to research from Grupo Cibest, the holding company that owns Bancolombia, this strength has contained inflation but not corrected it. The bank's economists estimate that each percentage point of peso appreciation reduces annual goods inflation by 0.16 percentage points over twelve months.

The researchers found that a stronger currency has limited effect on consumer prices because many factors intervene between the exchange rate and what consumers pay at the register. These include inventory rotation, asymmetry in firms' pricing incentives, and margin recomposition. Firms have absorbed some of the shock from previous depreciations rather than passing it on to consumers, sacrificing profit margins instead.

The pass-through effect is also weakened by the size of the currency move. International evidence shows that as exchange-rate swings get larger, firms absorb a growing share of the shock in their margins and space out price adjustments to avoid revising them too often. This dynamic explains why despite an appreciation of nearly 20% over the past year, goods inflation has been rising for seven straight months.

Grupo Cibest expects that if the peso gives back part of its recent strength, the effect on prices will be larger than what the appreciation has delivered, because firms pass along cost increases faster than they pass along cost reductions. The ongoing fiscal debate and external financing conditions will drive where the dollar-peso rate goes from here.