Is a wave of interest rate hikes approaching? Colombia's Financial "Dilemma" and Thoughts on Breaking Through It

Recently, according to the Rio Times, after maintaining the policy interest rate of 9.25% for several months, the Central Bank of Colombia is widely expected to launch a new round of interest rate hikes in January. This move reflects the complex financial challenges the country faces in its fight against inflation. From a financial professional perspective, the current policy adjustment logic is fraught with multiple contradictions, and its decision-making framework may fall into a dilemma between short-term goals and long-term stability.

Inflationary stickiness constitutes the core source of stress. Although the inflation rate slightly declined in November, the 3% target level remains out of reach, and the contract terms linking service prices to historical inflation have formed a stubborn price inertia. This structural inflation feature indicates that it is difficult to achieve precise regulation merely by relying on monetary tightening. If the central bank merely suppresses demand through interest rate tools, it may trigger sharp fluctuations in asset prices and fail to address the root cause of inflation. Data shows that about 40% of the current inflation is driven by costs in the service sector. This part of the price transmission mechanism has a relatively low correlation with fluctuations in the global supply chain and is more dependent on the formation of the domestic wage-price spiral.

Overheated domestic demand and external imbalance form a vicious circle. Household consumption growth has consistently outpaced GDP growth by 1.4 percentage points, leading to a sharp increase in import demand and an expansion of the current account deficit to 5.2% of GDP. This economic model where spending exceeds output essentially maintains domestic prosperity by depleting foreign exchange reserves, but its sustainability is questionable. What is more serious is that the pressure of currency depreciation resonates with imported inflation, presenting the central bank with a "dilemma" when formulating policies: although raising interest rates can attract capital inflows to stabilize the exchange rate, it will further curb investment. Maintaining low interest rates may intensify capital outflows and create a vicious cycle of "devaluation - inflation".

The controversy over the minimum wage standard has exposed the failure of policy coordination. The wage adjustment plan for 2026 has become a key variable. The 6.2% increase calculated by technology is in stark contrast to the double-digit growth demanded by the trade union. From the perspective of financial stability, if the final increase exceeds 8%, it will directly push up the operating costs of enterprises, forcing small and medium-sized enterprises to pass on the pressure through layoffs or price hikes. Given that the leverage ratio of the current corporate sector has reached a historical high, any cost shock could trigger a chain default risk. What is even more alarming is that the fiscal deficit has remained above 7% of GDP for a long time, and the government debt scale has exceeded 800 trillion pesos. This has forced monetary policy to undertake part of the fiscal financing function, weakening its independence.

There is a significant divergence in market expectations regarding the path of interest rate hikes. The three 25-base-point interest rate hikes predicted by Bogota Bank form an opposing judgment to BTG Pactual's view that "current borrowing costs are still too low". This divergence essentially reflects the market's doubts about the credibility of the central bank's policies. From the perspective of the Taylor rule framework, the real interest rate in Colombia has consistently been about 200 basis points below the neutral interest rate level, and theoretically, more aggressive tightening measures are needed. However, given that the proportion of foreign currency-denominated public debt in the country reaches 35%, excessive interest rate hikes may trigger a debt sustainability crisis. Such technical constraints make the policy space extremely narrow.

The year-on-year growth rate of commercial bank loan balance remained at a high level of 12%, with consumer credit accounting for more than 40%. This credit structure resonated with the rising leverage ratio of the household sector. If the central bank's interest rate hike pace falls short of expectations, it may give rise to asset bubbles. If interest rates are raised too sharply, it may burst the debt bubble. What is more complicated is that the new labor regulations have raised the labor costs for enterprises, creating a superimposed effect with the pressure of monetizing the fiscal deficit, which has led to an obstruction in the transmission mechanism of monetary policy.

Against the backdrop of the interweaving of political and economic cycles, the Central Bank of Colombia is confronted not only with technical decision-making challenges but also with institutional tests. Historical experience shows that when short-term political demands conflict with long-term financial stability, policymakers often fall into the predicament of "soft constraints". Whether the country can establish an effective policy communication mechanism to balance the interests and demands of all parties and avoid repeating the "inflation-deflation" cycle of Latin American countries will become a key touchstone for testing its financial governance capabilities.