Interest rate cuts would be limited by wage pressures and inflation

Amid an economic context marked by fiscal fragility and inflationary risk, the Bank of the Republic has opted for a cautious stance in its monetary policy, as was evident after the bank's recent meeting, where the board of directors kept its financial benchmarks unchanged for another month.

In this regard, a recent report by BNP Paribas on the country's fiscal situation warns that interest rate cuts will be limited and intermittent for the remainder of the year, due to a series of internal pressures that restrict the issuer's room for maneuver.

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Analysts begin by recalling that the central bank decided to keep its policy rate stable at 9.25% at its last meeting, with a split vote in which four members voted to leave it unchanged, while three favored lowering it (two by 50 basis points and one by 25). For them, this internal fragmentation reflects the current dilemma between continuing to cut rates to stimulate the economy and containing fiscal and wage pressures that could reignite inflation.

That said, BNP Paribas anticipates that the cuts cycle will be "intermittent," meaning reductions could occur in the third quarter of 2025, but then a pause could occur in the fourth quarter, just as negotiations for the 2026 minimum wage begin.

" This process is taking place in a highly sensitive political context, which could introduce upward biases into salary and inflation expectations, especially in the face of the electoral cycle," the report explains.

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Structural deficiencies

One of the biggest obstacles to a more expansionary monetary policy is the country's fiscal deterioration. According to the National Bank of Peru (BNP), rising public debt, the persistent structural deficit, and the activation of the escape clause to suspend the fiscal rule are generating distrust in the markets. This situation is forcing the Central Bank of Peru (BanRep) to maintain a more contractionary stance, not only due to current inflation but also due to fears of unanchoring expectations.

In fact, the report notes that the central bank could even recalibrate the neutral real interest rate—one that neither stimulates nor slows the economy—in its next macroeconomic scenarios, due to these fiscal imbalances.

Although inflation has shown a downward trend, the context remains complex, and BNP Paribas projects inflation of 4.8% for 2025, above the market consensus of 4.4% and the 4.0% forecast by the Central Bank of the Republic.

Among the risk factors identified are increases in regulated prices (such as natural gas), a possible devaluation of the peso, and the impact of a potential increase in the minimum wage that exceeds productivity.

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Additionally, S&P's loss of investment grade, which follows Fitch's previous downgrade, worsens the outlook, given that with two rating agencies below the threshold, Colombia no longer has investment grade status, and this could trigger capital outflows from institutional portfolios that only invest in countries with that status.

BNP estimates that between US$2 billion and US$5 billion could leave the local TES market, putting pressure on the exchange rate and interest rates.

Relief points

However, the report acknowledges that there are some buffers. One of them is the new Total Return Swap (TRS) program, through which the Central Bank can provide liquidity using TES as collateral. This could help soften the pressure on the yield curve and the exchange rate in the event of a sudden capital outflow.

Finally, BNP Paribas' analysis issues a clear warning: the rate cut cycle will not be linear or broad; therefore, monetary policy will need to navigate cautiously amid inflationary pressures, fiscal tensions, and political noise. The real challenge for BanRep will not only be controlling inflation, but doing so without losing credibility in an environment that demands discipline, but also flexibility.