Uruguay Leads Latin America With First Rate Reduction

(Bloomberg) — Uruguay became the first inflation-targeting country in South America to start lowering borrowing costs after the economy entered a technical recession in the second half of 2022.

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The decision to cut its key rate a quarter point to 11.25% surprised market participants surveyed by the central bank who expected policymakers to leave the rate unchanged Wednesday.

The central bank had lifted its key rate 700 basis points to 11.5% between August 2021 and December 2022 as inflation accelerated to almost 10% last year. The monetary authority’s move marked its first rate cut since the central bank readopted a benchmark rate as its main policy tool in September 2020.

“The central bank’s stance comes mostly on the back of the positive evolution of the inflationary process which is starting to converge to the target range,” Juan Manuel Pazos, Chief Economist at brokerage TPCG, wrote in a note to clients.

Growth is being slowed after a drought hit the agriculture sector, one of Uruguay’s top exporters, leading the central bank to ease policy to stimulate the economy, Alberto Landeira, economist at brokerage Puente, said in an interview.

“The main reason the central bank started cutting rates before other countries is because we have a negative output gap,” Landeira said. “The drought is having a big impact on the economy.”

Major central banks across the region have kept interest rates at multi-year highs even as inflation gradually retreats after hitting double-digits in several countries during 2022. Policymakers are concerned that premature easing might collide with an upsurge in consumer prices that would damage their credibility. In neighboring Brazil, the economic fallout from high interest rates spurred President Luiz Inacio Lula da Silva to publicly chastise his central bank for strangling growth.

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Read More: Latin America Warns Markets of Long-Haul Fight Against Inflation

Uruguay’s central bank under the leadership of economist Diego Labat has come under fire from exporters who say high borrowing costs are contributing to an overvalued currency. The peso has appreciated 2.3% this year, after gaining about 12% in 2022.

A strong currency has helped curb inflation, which fell to a 20-month low of 7.3% in March. Even so, market participants are skeptical that policymakers will hit their target, with the central bank’s most recent monthly survey of analysts forecasting 6.95% inflation in December 2024.

In Central America, Costa Rica cut its leading interest rate to 8.50% from 9.00% last month.

(Updates with analyst comment in 4th paragraph. An earlier version of this story corrected the first paragraph to say Uruguay was the first South American country to cut rates)

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