After Inflationary Years, Uruguay Has a Shot at Price Stability

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Uruguay has an opportunity to tame chronically high inflation as a sluggish economy is keeping consumer prices in check, giving the central bank a chance to shore up its credibility before inflationary pressures return.

Consumer prices fell within policy makers’ 3% to 7% target range for the first time in three years with April’s 6.76% year-on-year print. The central bank, led by former Banco Santander SA executive Diego Labat, sees inflation slowing to about 6.3% by December, and 5.2% in 2022.

After Inflationary Years, Uruguay Has a Shot at Price Stability

The central bank will pivot away from its expansive monetary policy when appropriate to make sure inflation expectations converge with its target during the next two years, Labat said in an interview late Wednesday.

“Our monetary policy has credibility problems,” he said. “The only solution is to comply step by step with everything we announce.”

The central bank’s new communication strategy, which includes inflation guidance and more frequent policy meetings, has also helped cool consumer prices, Labat said.

The South American country boasts one of the strongest economies in the region, but for years has tolerated some of the highest levels of inflation among investment grade countries. The pandemic forced the central bank to prioritize the economy with loose monetary policy and measures aimed at keeping credit flowing. Last year’s 5.9% contraction in GDP and a slow recovery have tempered price gains and given policy makers room to keep their benchmark rate at 4.5% since they reintroduced the rate last September.

After Inflationary Years, Uruguay Has a Shot at Price Stability

Inflation expectations are still too high, Labat said. The central bank’s most recent survey of economists sees consumer prices rising 7% this year and 6.8% in 2022 when the monetary authority lowers the upper threshold of its target to 6%.

“Expectations and the convergence of those expectations matter to us,” Labat said. “We aren’t worried about occasional” inflationary pressures that might appear later this year, he said.

Credibility Gap

Uruguay has witnessed many false dawns in its frequently half-hearted efforts to lower inflation in recent years. Consumer prices briefly fell as low as 5.24% in mid-2017 only to hit a 16-year high of 11.05% in May 2020 due to a slide in the currency.

The government’s fiscal goals and upcoming wage negotiations that are congruent with lower inflation should help Uruguay ditch its habit of baking high inflation expectations into wages and prices, he said.

“We are trying to break that indexing process at a time when the current juncture helps us. Perhaps during a period of growth this process would have been much more difficult,” Labat said.

Private sector estimates put growth just shy of 2.7% this year. The central bank plans to review its current 3.5% forecast in late June, Labat said.

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