FED maintains U.S. interest rate and complicates BanRep’s room for maneuver in Colombia

The decision by the US Federal Reserve (Fed) to leave its interest rate unchanged at its May 7, 2025 meeting has generated strong repercussions in emerging markets, including Colombia. This move, which reinforces the attractiveness of dollar-denominated assets, could limit the ability of Banco de la República (BanRep) to continue cutting its own monetary policy rate at its next meeting on May 30.

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The Fed keeps the rate between 4.25% and 4.50%

The Federal Reserve decided for the third consecutive time to keep its benchmark interest rate in the range of 4.25 % to 4.50 %, despite increasing pressure from President Donald Trump to reduce financing costs amid an election context.

Fed Chairman Jerome Powell justified the decision by arguing that, although the U.S. economy shows signs of solid growth and a strong labor market, risks of inflation and rising unemployment persist. In addition, he mentioned the possibility that the Trump administration’s recent tariff policies will generate additional inflationary pressures, raising the risk of stagflation (economic stagnation with inflation).

“Acting prudently in the face of uncertainty is essential to avoid larger imbalances,” said Powell, who also reaffirmed the bank’s independence from any political pressure.

BanRep cut its rate in April, but faces dilemmas

On April 30, Colombia’s Banco de la República decided to reduce its monetary policy interest rate by 25 basis points, bringing it to 9.25 %. This was the first reduction of the year, after having kept it at 9.50% since December 2024.

BanRep’s decision responded to mixed signals: year-on-year inflation rose from 4.46% in March to 5.16% in April, reflecting a stagnation in the downward path towards the 3% target, and projected economic growth of 2.5% in the first quarter, driven mainly by private consumption and investment.

Despite the cut, the central bank’s manager, Leonardo Villar, was emphatic that monetary policy “remains contractionary” and that the board will remain cautious in the face of fiscal risks and the increasingly complex external environment.

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Effects of the Fed’s decision on Colombia

The Fed’s decision to maintain its high interest rate has three central effects that will have a direct impact on the next BanRep decision:

1. Dollar appreciation and imported inflation

The permanence of high rates in the United States strengthens the US dollar (USD) against emerging market currencies such as the Colombian peso (COP). This peso depreciation makes imports more expensive, which can fuel inflation through higher costs of goods, raw materials and fuel.

For BanRep, this phenomenon imposes a technical limit: if it continues to lower its rate too quickly, the peso could weaken further, intensifying inflationary pressures and de-anchoring market expectations.

2. Capital flows and rate differential

A second transmission channel is in the flow of international capital. With the Fed not cutting rates, the United States remains an attractive destination for global investment. This reinforces the phenomenon known as carry trade, where investors seek to take advantage of rate differentials between countries.

Although the Colombian rate continues to be high in relative terms (9.25% vs. 4.50% for the Fed), an additional cut could narrow the rate differential, generating capital outflows, peso depreciation and greater financial volatility.

3. Caution in BanRep’s next decision

In its most recent communiqué, the BanRep Board had already pointed out that “external conditions, especially movements in international rates,” would be key to define the pace of future reductions.

Given this scenario, the May 30, 2025 meeting is expected to be dominated by a cautious and technical approach, carefully assessing the impact of the exchange rate, imported inflation and the evolution of economic growth before any further tightening.

The central bank could temporarily pause the cycle of cuts, opting to wait for clearer signs of inflation convergence towards the 3% target and greater exchange rate stability.

Although the government has pushed for a more accelerated rate cut, the external environment significantly reduces this margin.

What to expect from the next BanRep meeting?

The Federal Reserve’s decision not to modify its interest rate consolidates an international outlook of high cost of money, strengthening of the dollar and capital outflows from emerging countries. For Banco de la República, this implies a need for additional caution at its next monetary policy meeting, scheduled for May 30, 2025, with inflation still far from the target and an exchange rate sensitive to external conditions, it is likely that BanRep will opt to maintain its rate or apply minimal and gradual cuts.

In this context, economic agents should be attentive to the central bank’s signals and to the evolution of the international market in order to plan investments, prices and financing decisions.