March 31 (Bloomberg) -- Colombia's economy probably expanded above 5 percent in the fourth quarter, making 2005 the fastest year of growth in a decade, as a strengthening peso and falling interest rates spurred a surge in consumer demand.

Gross domestic product, the broadest measure of a country's output of goods and services, grew 5.18 percent from the year- earlier period, according to the medium forecast of 15 analysts surveyed by Bloomberg, after growth of 5.75 percent in the third quarter. The statistics agency reports fourth-quarter growth today as well as 2004 growth revised to include changes in the way the agency measures industrial output.

``We're very optimistic about the economy's expansion judging by the strong readings of consumer confidence, which is a leading indicator of private consumption,'' said Carola Sandy, an economist at Credit Suisse First Boston Inc. in a telephone interview from New York. ``We also continue to see a lot of domestic investment.'' Sandy expects the economy to grow 5.40 percent for the full year and 5.20 percent in 2006.

Falling interest rates and improved confidence is encouraging Colombians to take out loans, leading banks to increase lending while paring their holdings of local government bonds, according to Sergio Clavijo, president of the National Association of Financial Institutions, known as ANIF.

Colombia's consumer confidence index rose to 25.1 in February from 13.32 a year earlier, according to Fedesarrollo, an independent think tank for economic studies. Consumer loans including credit cards rose 42 percent to 4.8 trillion pesos ($2 billion) in the first three months of 2006 compared with a year earlier, according to a March 24 report by the nation's bank association.

Home Loans

``Mortgage credit has been growing at a slow pace due to reluctance about taking out loans indexed to inflation,'' Clavijo, a former member of the central bank's board said in an interview. ``Banks are seeing the growth potential of this loan segment and now for the first time, we see these institutions offer 10, 15-year home loans at a fixed-rate of around 1 percent monthly.'' Home loans fell to 6.8 trillion pesos in December, compared with 10.9 trillion pesos in the same month in 2002.

In a bid to stem the peso's 3.5 percent, 12-month gain -- the 10th-best performance against the dollar of the 62 currencies tracked by Bloomberg -- the central bank kept the benchmark lending rate at 6 percent, a three year low, for a sixth straight month in its last meeting on March 17.

The bank has cut the rate four times since February 2004, bringing it down from 7.25 percent.

Lending Outlook

Colombia's benchmark index of 90-day deposit rates used by financial institutions as a peg for setting rates for loans followed the central bank's benchmark rate lower, dropping to 5.92 percent this week from 7.44 percent a year earlier.

Bancolombia on March 2 announced a new nominal fixed-rate for home loans of 1 percent monthly, 3 basis points less than its preferential rate. Following suit, BBVA Colombia, the country's third-biggest bank by assets and the leader in the mortgage market, cut its rate for home loans to 0.99 percent monthly for loans of up to 15 years.

``Banks have been adding to their portfolio of inflation- linked government debt to cushion against a loss in fixed-rate loans if inflation quickens,'' Clavijo said. ``As long as the central bank keeps inflation under control, we won't see much risk in these new mortgage rates.''

An increase in both interest rates abroad and the central bank's overnight lending rate will hurt growth this year, according to Daniel Castellanos, head analyst at BBVA Colombia, a unit of Spain's Banco Bilbao Vizcaya Argentaria SA.

Inflation Concern

Central bank board member Juan Mario Laserna on March 24 said the bank plans to raise interest rates this year in an effort to control inflation in 2007.

``We're expecting the economy to expand at a lower rate than last year,'' Castellanos said. ``As interest rates rise, consumer demand and investment become more costly, hurting two of the main motors of growth in 2005.'' Castellanos expects the economy to expand 5.1 percent in 2005, compared with 4.4 percent this year.

Colombia's 12-month inflation rate fell to 4.19 percent through February, its lowest level since 1962, from 4.56 percent through January. The central bank targets inflation between 4 percent and 5 percent this year.

Total investment in Colombia last year rose to 22 percent of GDP, the highest since 1994, from 15 percent in 2002, the year President Alvaro Uribe took office, according to the National Planning Department. Retail sales rose 9.3 percent in the year through December compared with the same period a year earlier, according to the statistics agency.

-- Editor: Jameson.

To contact the reporter on this story: Andrea Jaramillo in Bogota at ajaramillo1@bloomberg.net .