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Argentina Maintains Rate at 40 Percent After 3 Rapid-Fire Hikes

Argentina‘s central bank left its monetary policy rate at 40 percent after three sharp rate hikes in 12 days and said it expects to keep real interest rates at a significantly higher level than in the past as long as inflation remains above its forecast for this year and emerging markets are facing a scenario of greater instability.

The Central Bank of the Argentine Republic (BCRA) has raised its key rate by a massive 12.75 percentage points since April 27 in an effort to shore up the exchange rate of the peso and force down inflation that is far in excess of the government’s target for 2018 of 15 percent.

After the latest 675 basis point rate hike on Friday, May 4, there were signs of peso stabilization but earlier today it continued to tumble until Argentina’s president, Mauricio Macri, announced on television that his government was seeking a line of credit from the International Monetary Fund (IMF) to “avoid a crises like the ones we have faced before in our history.”

Macri’s decision to turn to the IMF will bring back memories for many Argentines who still blame the Washington D.C.-based institution for letting the country’s debt soar and trigger the 2001 debt crises by allowing it keep an exchange rate that pegged the peso to the U.S. dollar.

Macri, who is facing election in October 2019, took office in December 2015 promising to end the country’s isolation from international financial markets, tackle high government spending on subsidies, and lower the fiscal deficit and inflation.

Christine Lagarde, IMF managing director, welcomed Macri’s statement and said discussions had been initiated with Argentina on how its economy could be strengthened and “these will be pursued in short order.”

After spiking to 23.14 to the U.S. dollar, the peso ended today around 22.35 to the dollar, down 9.4 percent since April 26, the day before the first of three rate hikes. Compared with the start of this year the peso has lost 16.8 percent and compared with the start of 2017 it is down almost 30 percent.

In today’s longer-than-usual statement, the central bank noted the recent instability in the currency market, saying the normal menu of options available to a central bank include allowing the currency to depreciate, carry out interventions to avoid a currency overreaction by investors and raising interest rates to moderate the inflationary impact.

BCRA noted its initial decision was to intervene in the foreign exchange market to contain the depreciation followed by letting the peso slide as it became convinced the pressure on the peso was not just an isolated episode but part of a deeper shock to emerging market currencies.

At the same time, the central bank raised its monetary policy rate by 1,275 basis points until it reached the current rate of 40 percent in three steps, starting on April 27, then May 3 and then May 4.

In addition, the central bank also widened the interest rate corridor to allow domestic assets to move more freely and was active in the secondary paper market.

Given the unusual situation and the use of exceptional tools, the central bank said it was appropriate to share its vision about the near future.

First, the BCRA confirmed that its monetary policy regime is based on interest rates with a floating exchange rate that absorbs external shocks, with interventions only in exceptional cases when the movements can be disruptive to the process of lower inflation.

Secondly, as the market stabilizes, the central bank will normalize its operations and return to a narrower corridor that allows the policy rate to be automatically transmitted to other interest rates.

Thirdly, with regard to the reference rate, the central bank considers that it will be necessary for the level of real interest rates to be significantly higher than before recent changes when inflation is above that forecast for 2018 and when there is a situation of greater instability in emerging markets.

The current bout of peso weakness and investor nervousness stems from Macri’s decision on Dec. 28, 2017 to push back the goal of lowering inflation to 5 percent by one year to 2020 and raise the inflation target to 15 percent from a previous 8-12 percent.

On Jan. 9 and Jan. 23 the central bank then lowered its key rate in two steps by a total of 150 basis points, arguing the rise in inflation is transitory and it will continue its downward trend once the one-off impact of a higher in regulated prices dissipates.

But inflation is still rising and rose to 25.6 percent in March from 25.4 percent in February.

Although the depreciation of the peso is likely to impact local prices, the central bank said many of its trading partners have also seen their currencies depreciate, moderating some of that impact.
The latest survey showed a rise in 2018 inflation expectations to 22 percent from 20.3 percent for headline inflation and to 19.8 percent from 18.1 percent for core inflation, BCRA said.
This article originally appeared on CentralBankNews.info and is reproduced here with permission from the author.

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