It is the first rate hike by the BCRD since April 2017 and the first change in rates since August last year when the rate was slashed by 50 basis points.
In addition to raising the monetary policy interest rate, the central bank raised the deposit rate by 25 basis points to 4.0 percent and the rate on its permanent expansion facilities (repos) by the same amount to 7.0 percent.
BCRD said it changed its monetary policy to achieve its inflation goal as inflation was forecast to gradually rise due to higher oil prices, pressure from domestic demand and increased uncertainty in international financial markets.
In a statement from July 24, the BCRD noted that cumulative inflation in the first six months of this year was 1.43 percent so the annual inflation rate in June had risen to 4.63 percent, above the bank's midpoint target range of 4.0 percent, plus/minus 1 percentage point.
Inflation in the Dominican Republic has risen steadily since 3.32 percent in February and June inflation was the highest rate since October 2013.
As the United States continues to normalize its monetary policy, BCRD said international financial conditions are becoming less favorable and this has increased risk premiums and long-term interest rates for emerging economies.
"The higher interest rates in the US have also generated an appreciating trend in the dollar, which together with higher oil prices, has contributed to an increase in the depreciation of the currencies of developing countries," BCRD said.
The Dominican peso has been relatively stable since March, in contrast to a steady depreciation against the U.S. dollar in the last decade.
The peso was trading at 49.76 to the U.S. dollar today, down 4 percent this year.
However, despite the changing international financial conditions, BRCR said the economy in emerging countries remains in a positive trend and in Latin America, with the exception of Venezuela, there would be positive growth of 2.0 percent this year despite the moderation seen in such large economies as Argentina and Brazil.
Domestically, the economy is also continuing to evolve in a favorable manner, with the monthly indicator of economic activity (IMAE) showing cumulative growth of 6.6 percent in the first five months of the year. The trend cycle rose by an annual 6.9 percent in May, showing that the economy would continue to grow above potential in the rest of this year.
"To the extent that this growth path is maintained and generates pressures on future domestic prices, monetary policy would continue to move towards the withdrawal of the monetary stimulus launched last year," BCRD said, adding "in this way, important deviations in the differential between domestic interest rates and those of the US would be avoided."
The Central Bank of the Dominican Republic issued the following statement:
"At its monetary policy meeting in July 2018, the Central Bank of the Dominican Republic (BCRD) decided to increase its monetary policy interest rate by 25 basis points, from 5.25% to 5.50% per annum. According to the short-term liquidity management scheme of the BCRD, the rate of paid deposits (overnight) increases from 3.75% to 4.00% per year and the rate of permanent expansion facilities (repos), increases from 6.75% to 7.00 % annual
The decision to increase the reference rate was based on an exhaustive analysis of the risk balance around inflation projections, the main national macroeconomic indicators, the relevant international environment, market expectations and medium-term forecasts. During the first six months of the year, cumulative inflation was 1.43%, so the year-on-year inflation from June 2017 to June 2018 was 4.63%, above the midpoint of the target range of 4.0% ± 1.0% established in the Monetary Program.
Prior to the meeting, inflation forecasts in a passive scenario indicated a gradual upward trend, as a result of higher oil prices, domestic demand pressures and an increase in uncertainty in international financial markets, which evidenced the need of a change of position in the monetary policy that seeks to achieve the goal within the two-year policy horizon.
In the external environment, a positive trend is observed, albeit with moderate growth in some advanced economies. Consensus Forecast projects a year-on-year increase in real world production of 3.3% in 2018 and 3.2% in 2019. The United States of America (USA) would continue to lead the industrialized countries with an economy that operates at full employment and that presents growth projections for 2.9% in 2018 and 2.6% in 2019. It would be followed by the economy of the Euro Zone (ZE), whose real product would increase by 2.2% and 1.8%, respectively, during those years. As a result of the dynamism of the US and the rise in oil prices in the international market, inflationary pressures have increased in that country. To counteract them, The Federal Reserve (FED) has continued with its monetary normalization process, increasing the policy rate by 50 basis points so far this year. The FED's rate adjustments would continue for the remainder of 2018 and 2019.
As the US advances in the normalization of its monetary policy, international financial conditions become less favorable, which has increased risk premiums and long-term interest rates for emerging economies. The higher interest rates in the US have also generated an appreciating trend in the dollar, which together with higher oil prices, has contributed to an increase in the depreciation of the currencies of developing countries.
It is important to note that despite this environment of change in international financial conditions, the economic performance of emerging countries maintains a positive trend. India would be growing 7.3% in 2018 and 7.5% in 2019, while China would expand by 6.6% and 6.4% in those years, respectively. As far as Latin America (LA) is concerned, all economies, with the exception of Venezuela, would present positive growth this year. As a region, AL would expand 2.0% in 2018 and 2.5% in 2019, according to Consensus Forecast. It should be noted that this growth would occur despite the moderation observed in some large economies such as Argentina and Brazil.
In the internal context, economic activity continues to evolve favorably, as can be observed in the trajectory of the monthly indicator of economic activity (IMAE). In effect, according to preliminary data, the IMAE recorded an accumulated growth of 6.6% in the period January-May 2018. In this way, the IMAE trend-cycle expands at an annual rate of 6.9% in the month of May, projecting that the economy would keep growing above its potential throughout the year. To the extent that this growth path is maintained and generates pressures on future domestic prices, monetary policy would continue to move towards the withdrawal of the monetary stimulus launched last year. In this way, important deviations in the differential between domestic interest rates and those of the US would be avoided,
Consistent with this evolution of the economy, dynamism in the domestic financial market continues, reflected in an increase in credit to the private sector in national currency above the estimated expansion of nominal GDP. In this sense, as of July, private loans in local currency grew at an interannual rate close to 13%, while monetary aggregates expanded above the Monetary Program.
In terms of fiscal policy, revenue so far this year has remained within the budgeted amounts, while a moderate level of expenditure has been recorded, which has allowed a fiscal surplus to be reached in the first five months of the year. This behavior of public finances would facilitate compliance with the deficit target, established in the National Budget. In the external sector, the dynamism registered in the foreign exchange generating activities has contributed substantially to moderate the impact of higher oil prices on the Dominican economy. Likewise, international reserves have remained at historically high levels, which contributes to the relative stability of the exchange market.
The Central Bank of the Dominican Republic reaffirms its commitment to conduct monetary policy to achieve the inflation target and maintain macroeconomic stability. In this sense, if necessary, the institution is prepared to continue normalizing its monetary policy in the following months, in line with the evolution of the world economy, as well as with the main domestic risks. In addition to promoting control of inflation and macroeconomic stability, monetary policy measures ensure the proper functioning of the financial and payment systems."
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