Inflation is receding but political uncertainty keeps the risk premium high

ARGENTINA - Report 21 Dec 2018 by Domingo Cavallo and Esteban Fernández Medrano

​Monthly inflation went down in November and will probably recede even more in December. This is the consequence of the stability of the exchange rate that was achieved since the beginning of October when the Central Bank announced its constant monetary base target for the period October 2018 to June 2019.

For the time being, the issuance of LELIQs, a 7 days’ peso liability of the Central Bank which is not computed as Monetary Base, allows the Central Bank to neutralize the liquidity created by the cancellation of LEBACs and any other peso payments by the Central Bank. Of course, this monetary strategy required accepting quite high interest rates on LELIQs.

Even though the receding of inflation made room for some reduction in the LELIQs interest rate, the Central Bank will not let it down too rapidly in order to avoid a new upsurge of peso depreciation. In fact, to reach along 2019 the 1.8% monthly average rate of inflation that prevailed since April 2016 to April 2018, before the currency crises in May and September, the Central Bank will have to keep the nominal exchange rate increasing at an average monthly rate not higher than 2%.

The Achilles heel of this monetary policy, combined with a significant effort to balance the primary budget in 2019, is the aggravation of the recession in the short run and the probable delay in the recovery of the level of economic activity.

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