Uruguay raised its base rate by a full percentage point this week “with the objective of creating an impact on inflation expectations”, economy minister Fernando Lorenzo told Emerging Markets.
The increase took the base rate to 7.5%. It followed an announcement that the official inflation rate rose to 7.7% in February, while Uruguay’s inflation target band is between 4% and 7%.
“Every time we have a deviation from the target, we need to act with monetary policy,” Lorenzo said.
While some countries such as Brazil are flirting with capital controls, Lorenzo insisted that Uruguay will stick to its traditional liberal stance.
“We have been facing an intense process of capital inflows in the whole region. We [Uruguay] have a very liberal framework in terms of capital flows, and there is no plan to change this,” he said.
Earlier, the Central Bank of Uruguay expressed “concerns about the risk implied by the evolution of inflation, in a context of elevated growth”.
Uruguay registered economic growth of 8.5% last year. Inflation amounted to 6.9% last year and gathered even more momentum this year, even though some price increases were delayed.
“We have some inflationary pressures”, Lorenzo said. “This is our response in terms of our commitment to the range of inflation set by the macroeconomic committee set up by the Central Bank and the economy ministry.”
Earlier this month, Chile raised its benchmark interest rate from 3.5% to 4% per year, and Peru, which has tightened monetary policy aggressively, recently raised its interest rates for the third consecutive month to 3.75% per year.
Brazil hiked its benchmark rate by half a percentage point for the second time this year. The Selic rate (i.e. Central Bank overnight rate) now amounts to 11.75% per year, the highest in the region.
Latin American policymakers acknowledge that high interest rates are the most powerful means to contain inflationary pressures – even though higher interest rates encourage even stronger capital inflows, which in turn lead to currency appreciation.
Brazil has tried to complement its traditional monetary policy with a series of macro prudential measures. Since the end of last year, the central bank has announced a hike in bank reserve requirement and capital equity ratios. It has also hinted that it is poised to unveil additional quantitative measures, which may be a way to ease the tightening cycle.
Meanwhile in Uruguay, policymakers seem determined to go all the way. “Inflationary pressures have two basic causes – oil and food prices. The best way to deal with it is through fiscal and monetary policy,” Lorenzo said. “We have a firm commitment on the inflation target, which is between 4% and 7% this year.”