Uruguay’s formula to raise rates without causing risk to economy, says Central Bank

Uruguay’s strategy of gradually raising interest rates over the rest of the year should be enough to curb inflation near 10% without causing a sharp economic slowdown, according to Central Bank of Uruguay (BCU) president Diego Labat.

Labat said that the bank’s return to a regime of inflation targeting set in 2020 remains a “work in progress” that merits a measured approach, as it is unclear how inflation expectations would react to a faster tightening.

“We understand that an overreaction from us also doesn’t generate the immediate results as perhaps it might elsewhere,” Labat said in an interview Monday. “We prefer steady hikes over a longer period, ” reducing the risk of “stress” to the economy.

Uruguay’s approach contrasts with neighboring Brazil, which aggressively tightened monetary policy in response to rising consumer prices but has left rates unchanged since August.

The BCU signaled this month that it would raise its benchmark rate by half a percentage point at each of the next two meetings, to 11.75% in December, and ten increases from August 2021.

Labat declined to comment on whether the bank will continue to raise its borrowing costs next year. He added that he expects inflation to fall to its 3% to 6% target before President Luis Lacalle Pou finishes his term in early 2025.

Consumer price increases will take longer than expected to come down due to the pandemic and Russia’s invasion of Ukraine, Labat said.

The central bank expects inflation to decline from 9.95% last month to around 9.5% in December.

INFLATION OUTLIER

Uruguay has long had higher inflation than its regional peers. The weight of unions and a heavily regulated labor market mean that wages tend to match or exceed inflation, while commercial contracts are structured to protect the parties from price changes.

According to International Monetary Fund forecasts, the economy will expand 5.3% this year, slowing to 3.6% in 2023.

Rising interest rates, a stable economy, and high commodity prices have helped the Uruguayan peso strengthen 8.5% this year, making it the best-performing currency in the Americas.

“Today’s exchange rate is the best reflection of all the information available in the market,” Labat said when asked if the currency is overvalued.

With information from Bloomberg