A 10% Jump in Minimum Wage Puts Colombia Central Bank in a Bind

(Bloomberg) -- Colombia’s biggest minimum-wage increase in 50 years is adding pressure on the central bank to raise rates faster and further before an inflation spiral takes hold. 

The 10% pay hike goes into effect Jan. 1, and policy makers are voicing concerns that the infusion of cash into the economy could add fuel to consumer-price increases that have already been running above target. At the same time, the government is mulling plans to pull back on subsidies that have kept fuel prices artificially low, potentially providing an additional boost to inflation. 

Since unions, the government and business groups reached the agreement on wages two weeks ago, traders and economists have quickly ratcheted up wagers on how high the central bank will need to increase interest rates to get a handle on inflation. While few would begrudge more generous wages for some of Colombia’s poorest citizens -- the increase brings the minimum to just $250 a month -- the risk is that it eventually leads to interest rates so high that they strangle much-needed economic growth. 

“We knew the minimum wage increase was going to be high given inflation has been on the rise, but this 10% increase is way beyond what anybody was expecting,” said Camilo Perez, the head analyst at Banco de Bogota. “The reality is that a lot of prices may now be set with that number in mind.”

Politicians promoting the minimum-wage increase -- which would be the biggest in five decades when accounting for the previous year’s inflation -- said it was needed considering the rising cost of living and to provide some relief from the pandemic. Still, a large percentage of Colombia’s workforce is employed in informal positions that don’t come with rules on salaries or benefits, and therefore won’t be helped by the increase. A full 46% of workers make less than the minimum, according to Colombia’s statistics agency, so inflation could be particularly painful for them.

The swaps market signals expectations that the central bank’s overnight lending rate will more than double over the next year to 6.6%, a full percentage point higher than the market was showing just two months ago, as policy makers seek to bring inflation down to their target of 3% from the current 5.3%. Officials said in the minutes of their December policy meeting that higher wages could contribute to the de-anchoring of inflation expectations. 

The minimum-wage plan “generates a particularly great challenge for the central bank and the fulfillment of its constitutional mandate,” central bank Governor Leonardo Villar told journalists Dec. 17. 

In the same central bank news conference, Finance Minister Jose Manuel Restrepo said fuel prices will need to rise in the coming months to narrow the gap with international costs as the nation pulls back on subsidies. 

Gasoline in Colombia averages about $0.60 per liter ($2.20 a gallon) after increasing just 8% this year, while Brent crude has advanced more than 50%. The Energy Ministry said this month that domestic fuel costs would be as much as 35% higher if the subsidies didn’t exist.

Cheaper fuel has helped Colombia post the lowest inflation rate among major Latin American economies, according to the most recent data. Brazil’s rate is twice as high at 10.7%, while Mexico is at 7.4% and Chile at 6.7%. Colombia’s advantage comes from gasoline prices, according to Felipe Campos, an analyst at Alianza Valores. 

“Today the price of gasoline is only comparable to that of Bolivia and Ecuador because it is highly subsidized,” Campos said by phone. 

In the most recent policy decision, the central bank’s board voted 4 to 3 to increase the benchmark by half a percentage point to 3%, with the minority favoring a hike of 75 basis points. 

That signaled to some analysts that future increases were likely to come in 75-basis-point increments. BTG Pactual forecasts policy makers will deliver 150 basis points of rate hikes by February, and that the rate will peak next year at 5.5%, up from its previous estimate of 5%. 

While still expecting increments of 50 basis points, Bank of America also now sees the key interest rate ending next year at 5.5%, up from a previous forecast of 5%.

“It’s highly likely that the minimum wage hike will pressure inflation up meaningfully,” Alexander Muller, an Andean economist for Bank of America, wrote in a report after the central bank’s December meeting. “The minimum wage policy does have significant bite.”

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