The first South American central bank to cut rates speaks of caution

(Bloomberg Opinion) — South America’s central bank, the first to cut interest rates this year, is pledging to maintain tight monetary policy with moderate additional cuts in 2023 to keep consumer price increases and inflation expectations on track.

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Uruguay’s central bank cut its benchmark rate by a quarter point to 11.25% in April and kept it unchanged in May. The central bank’s latest forecast is for a gradual rate cut in 2023, with cuts increasing to 8% next year.

„We understand that the conditions are there for these rates to fall, understanding that inflation and expectations are moving towards the target range,” the company’s president, Diego Labat, said in an interview. The benchmark rate will contract briefly during the easing cycle, he added.

Labatt said inflation could enter the target range of 3-6% from the first quarter of next year.

Most of Latin America’s central banks have not cut interest rates after nearly two years of tight monetary policy, as they wait for further confirmation that cooling inflation will hit their targets.

Before the post-pandemic reopening and the war in Ukraine, Uruguay already had one of the highest inflation rates in the region (an average of 8.6% per year since 2000). Consumer prices rose 7.1% in May, the slowest pace in two years, led by a big drop in fruit and vegetable prices.

Tighter monetary policy and economic growth of about 2% should keep inflation down, although unions are likely to win real wage increases in wage negotiations this year, Labat said.

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Development Impact

After growing 4.9% last year, Uruguay’s economy is slowing sharply as a record drought prompts the government to target an 11% drop in exports by 2023.

In a move that could boost trade, the central bank is in talks with its counterpart in Argentina to implement a bilateral payment system that would allow importers and exporters to pay in local currencies instead of US dollars, Labat said.

The Local Currency Payment System, or SML, is run by the central banks of Argentina, Brazil, Paraguay, and Uruguay. Uruguayan exporters want to renew the SML so that dollar-hungry Argentine companies can buy their products.

Argentina’s economic crisis is also robbing its neighbors of growth, prompting Uruguayans to cross the border to buy cheap food and fuel or take deeply discounted vacations to tourist destinations like Buenos Aires. With a shortage of dollars in Argentina and inflation running at 100%, local businesses are unable to compete and basic consumer goods are less than half the price in Uruguay.

This trend helps reduce inflation in Uruguay. „It’s a factor that clearly helps the margin,” Labatt said.

Looking ahead, the central bank sees positive developments on the inflation front, he said.

„To the extent that we see expectations moving toward the range, this rate drop is possible for us. As I said, it will be as slow as necessary and as the data evolves,” Labatt said.

Translated by Malu Poveda.

Nota Original: Restricted First South American Central Bank Says Warning Needed

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