Declining inflation suggests rate cuts will continue

URUGUAY - Report 12 Jun 2023 by Esteban Fernández Medrano

While April's trade data reflected worse-than-expected results due to poor export performance, inflation improved significantly in May, particularly the PPI. As reserves and labor productivity remain stable enough to overcome the agricultural export slowdown we see no significant risk in the asset class and would expect the Central Bank to continue easing its monetary policy in the coming months.

May annual CPI inflation retook a declining path after April showed a mild rebound above seasonal expectations. This convinced the Central Bank to keep interest rates constant at 11.25% at its most recent COPOM meeting on May 16. With a monthly rate of 0.0% m/m, annual CPI inflation fell to 7.1% y/y in May. Furthermore, producer price inflation also fell significantly, with a -1.4% m/m contraction, summing to a whopping -9.0% y/y deflation, the largest annual inflation decline since the late 1960s, when the PPI was created.

In contrast, the April trade balance registered a deficit of USD 328mn, accumulating a deficit of USD -2.2bn over the last 12 months. This represents the largest annual trade deficit since August 2015. This behavior is largely explained by a sharp drop in exports, particularly of food and beverages (-25.9% y/y) and primary exports (-33% y/y, of which livestock exports contracted by -72.4% y/y). Naturally, both indicators were severely affected by the harsh drought in the region. Furthermore, this weak export performance contrasts with relatively strong imports of food and beverages (+12.9% y/y) and durables consumption at 46.3% y/y, supported by the relative strength of the Uruguayan peso. However, when analyzing the 12-month moving average, so as to eliminate seasonal factors and smooth the time series, the picture seems less worrisome.

Therefore, while the April trade results were worse than expected, the combined inflation results (with deflation in food prices) allow us to anticipate that the Central Bank will most likely consider cutting rates again at the upcoming COPOM meetings (to take place on July 6 and August 15). We think the cuts will probably be only a moderate 25bps (particularly in an environment in which the US is hiking interest rates), but a heftier 50pbs could be in the cards, depending upon the upcoming activity data.

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