Uruguay Central Banker Predicts Inflation to Fall to 7% in 2021

(Bloomberg) -- Uruguay, the investment grade country with the world’s highest inflation rate, sees consumer price increases slowing more than analyst expectations even as monetary policy remains focused on stimulating the economy.

After spiking to a 16-year-high in May, the bank expects inflation will dip below 7% for the first time since 2018 next year, central bank chairman Diego Labat said in a video interview. The central bank also sees price gains falling below 6% in 2022 when it adopts a 3%-6% target range in September that year.

While annual inflation has eased to 9.7% from 11.1% in May, the central bank believes a mix of clear messaging, the use of a key rate as an anchor and a plan to de-dollarize the economy will bear fruits, Labat said.

“The best contribution that the central bank can make to growth is working to have inflation that is much lower what we have today,” he said.

Uruguay, the South American country of 3.5 million people wedged between Argentina and Brazil, has enjoyed greater economic and financial stability than its regional peers in recent years with some of the lowest borrowing costs in Latin America but has been unable to tame price increases. Its current annual inflation rate is more than double that of Mexico’s, the next highest country among investment grade credits, which last reported a rate of 4.09%.

Private estimates show analysts aren’t as optimistic on short term inflation relief.

​More than two dozen analysts who participated in the bank’s most recent monthly inflation survey forecast consumer prices to rise 7.6% in 2021 and 7% the year after. Except for brief periods in 2017 and 2018, inflation has consistently printed above the bank’s target.

“I’m not comfortable with those expectations. We have to bring expectations within the target range,” he said.

The bank will hold its benchmark rate at 4.5% through at least March, Labat said, describing the level as expansionary, in a bid to help growth as borders remain shut to tourists to preserve low coronavirus infection levels.

While it’s rare to have a key rate so far below the inflation rate-- Labat acknowledged that it’s one of the lowest real rates in the region -- he added that the central bank’s current focus is to support the economy. The bank expects the economy to contract around 4% this year before growing just under 4% in 2021.

Rate System

The key rate was reintroduced in September after seven years of trying to control inflation through changes in the money supply.

“We’d have to see a level of activity that is much more dynamic, which we still aren’t seeing today” to tighten policy after the Southern hemisphere summer, he said. “It also depends a little on how inflation expectations evolve.”

The bank needs low inflation to advance on another key policy objective of reducing the outsized role of the U.S. dollar in the economy, Labat said.

Uruguayans have little confidence in their own currency due to a legacy of devaluations, money printing and rampant inflation during the 20th century. Even today, about three quarters of bank deposits are in dollars, while cars, homes and expensive consumer goods like TVs are also priced in greenbacks.

The bank plans to lower reserve requirements on peso deposits before the end of the year to encourage savings in the local currency and create incentives for Uruguayans to use the peso in more transactions, Labat said.

“I realize that it will take more time for people to save in pesos” but increasing local currency transactions is an important first step that will “naturally lead to more local currency deposits,” he said.

©2020 Bloomberg L.P.