(Bloomberg) -- The first South American central bank to lower interest rates this year pledges to maintain a restrictive monetary policy, with only modest additional cuts in 2023, to keep consumer price increases and inflation expectations on a downward path.
Uruguay’s central bank cut its benchmark rate by a quarter point to 11.25% in April and left it unchanged in May. The central bank’s most recent forecast shows the rate gradually falling through 2023, with cuts accelerating next year to leave it around 8%.
“We believe the conditions are there for that drop in rates to happen with the understanding that inflation and expectations converge within the target range,” chairman Diego Labat said in an interview. The benchmark rate will remain contractive for some time during the easing cycle, he added.
Inflation could enter the 3%-to-6% target range as soon as the first quarter of next year, Labat said.
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Most central banks in Latin America still haven’t pivoted to cutting rates after almost two years of tight monetary policy as they await further confirmation that cooling inflation will reach their targets.
Uruguay was already a high-inflation outlier in the region — 8.6% per year on average since 2000 — even before the pandemic reopening and the war in Ukraine sent consumer prices soaring to multiyear highs. Consumer prices rose 7.1% in May, the slowest pace in two years, led by a big drop in fruit and vegetable prices.
Tight monetary policy and economic growth of around 2% should cool inflation even though unions will probably win real wage gains in salary negotiations this year, Labat said.
After growing 4.9% last year, Uruguay’s economy is set to slow dramatically as a record drought has the government penciling in an 11% drop in exports in 2023.
In an initiative that may bolster trade, the central bank is negotiating with its counterpart in Argentina to activate a bi-lateral payment system that allows importers and exporters to make payments in local currencies instead of the US dollar, Labat said.
SML, as it’s known by its Spanish acronym, is run by the central banks of Argentina, Brazil, Paraguay and Uruguay. Uruguayan exporters want to revamp SML so dollar-starved Argentine companies can buy their goods.
Argentina’s economic crisis is also stealing some growth from its neighbor as Uruguayans flood across the border to buy cheap food and fuel or enjoy deeply discounted vacations in tourist hot spots like Buenos Aires. Dollar shortages and inflation of more than 100% in Argentina mean basic consumer goods cost less than half the price in Uruguay, where local businesses are struggling to compete.
That trend is helping cool inflation in Uruguay. “It’s a factor that clearly helps on the margin,” Labat said.
Looking ahead, he said the central bank sees positive developments on the inflation front.
“As we see that expectations are converging toward the target range that will allow rates to come down. But as I said, it will be as slow as necessary” and data dependent, Labat said.
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