MercoPress. South Atlantic News Agency

Uruguay leaves benchmark rate unchanged; fears of slower economy and too strong Peso

Inflation but also a too strong Uruguayan Peso are the challenges for Uruguay’s Central bank

Uruguay’s central bank surprised the market by keeping on hold the benchmark interest rate at 9.25% after increases at the two previous monetary policy meetings failed to slow inflation, one of the country’s main concerns.

The benchmark rate was increased 25 basis points in September and December. But apparently the collapse of the US dollar against the Uruguayan Peso (making imports cheaper and exports dearer) and a slower economy seem to have gained ground.

The release from the bank’s monetary committee said that “inflation continues to be one of the main concerns in the map of risks” of Uruguay’s economy, adding that its decision to hold rates took into account a recent increase in reserve requirements in the banking system. But there is also “a balance of targets for the economic policy” that must be taken into account.

Annual inflation accelerated in February to 8.89% from 8.72% in January and has remained above the bank’s target of 4 to 6% since 2009. Consumer prices will rise 8% this year, according to the median estimate of economists in a central bank survey released this month, compared with 7.5% forecast in January.

Inflation won’t slow to within the central bank’s target range this year because of robust domestic demand, Central Bank President Mario Bergara said in a March 15 interview. Annual inflation of around 8% to 9% is manageable and stems from rising incomes and prices for soy and meat exports, Bergara said.

The central bank on December 13 reported that Uruguay’s economy expanded 3% in the third quarter from a year earlier and 1.2% from the previous quarter.

Bergara advanced that the economy had ‘probably’ expanded between 3% and 3.5% last year, which is below the 4% target. The bank will release fourth-quarter and 2012 growth on March 27. According to the medium estimate from economists surveyed by the central bank this month the economy is poised to expand 3.86% in 2013 from 3.9% in 2012.

Uruguay’s credit rating was raised to investment grade by Standard & Poor’s in April and by Moody’s Investors Service in July after the country reduced debt and diversified exports. Fitch Ratings places the country one level below investment grade.

In the release the bank says that the Uruguayan economy is growing at a reasonable rate, even higher than those in the international scenario, but also admits that “there is a balance between goods and services exports, private investment and strong domestic demand which does not allow mitigating the inflationary impulse at the desired rhythm”.

The release underlines the global economy ‘uncertainty’ and the continuity of international interest rates ‘extremely low’ with persistence of ‘capital inflows towards emerging economies’.

Uruguay’s Centre for Economic Research, CINVE, said that the central bank release shows a dual target since a further increase in the benchmark rate would have had a minimum impact on expectations and domestic credit, but on the other hand there is the need to impede a further strengthening of the Uruguayan Peso which is “seriously affecting competitiveness and the growth of the economy”

Economist Gabriela Mordecki from the Economics Institute at the University of the Republic said the bank’s decision was the best option: wait and see the effect of the higher reserve requirements for the banking system. “Increasing the benchmark rate means further pressure on the exchange rate appreciating the Peso and demanding a greater para-fiscal cost”.

“The year ahead will see slower growth in real salaries and less prospects of sustained advance of the economy; a less stable labour market could make consumers more cautions on expenditure and this by itself should help ease pressure on inflation”, said Mordecki.