Argentina: Central Bank tightens monetary conditions despite plunging economic activity
August 13, 2018
In a pair of meetings in August, the Central Bank of Argentina (Banco Central de la República Argentina, BCRA) decided to change its key policy instrument from the seven-day repo reference rate (seven-day LEBAC rate) to the seven-day liquidity bills rate (seven-day LELIQ rate). On the heels of the 8 August seven-day LELIQ rate increase from 37.00% to 40.00%—the same level at which the seven-day repo reference rate was previously held—a second hike to 45.00% came on 13 August as it became clear a stronger response to market turbulence was necessary. The moves do not represent a substantial shift, as the markets for both LEBAC and LELIQ are operated by local banks; the key difference is that LELIQ is not subject to the gross income tax payment. The Bank decided to change the policy rate as the BCRA is gradually reducing the stock of LEBAC and therefore the seven-day LEBAC rate will diminish in importance going forward.
The unexpected moves were the Bank’s latest attempt to restore confidence following a heavy devaluation of the peso and intervention from the International Monetary Fund. Surging inflation drove the Central Bank’s decision, as were concerns over the emerging-market fallout from Turkey’s lira crisis. According to the National Statistics Institute (INDEC), national consumer prices jumped 3.7% month-on-month in June, which was notably higher than May’s 2.1% increase and was influenced by strong pass-through effects from a weaker currency. Although the Bank expects inflation to decelerate in the August–October period, the scope of the deceleration will be restrained by planned hikes in regulated prices. Given it considers financial stability essential to growth, contracting economic activity in both April and May did not prevent the Bank from sticking to a hawkish stance. Moreover, the expected rebound in agricultural production and the stabilization of financial markets will gradually lead to a recovery in economic activity, although it will take some time to materialize.
In its second note, the Bank stated it would hold off on further policy changes until at least October. External risks persist, however, and the economy will remain vulnerable to the ongoing emerging-market selloff. In the meantime, the government's ongoing efforts to curb public expenditure and the BCRA’s commitment not to finance the Treasury should help contain runaway inflation. A tight monetary stance is viewed as essential to anchoring market expectations and bringing inflation to target.
The next monetary policy meeting will be held on 11 September.
Author: Christopher Thomas, Economist