WASHINGTON (AFP) ― Moody’s lowered its credit rating for Argentina by one step Monday, citing a sharp fall in the country’s reserves and inconsistent economic policies.

The fresh blow to the country came as Buenos Aires reported that prices rose 3.4 percent in February over January, taking the annual inflation pace to more than 40 percent.

Moody’s cut the rating to “Caa1” from “B3,” putting it in the mid-range of “speculative” or junk bonds.

The agency also cut its outlook for Argentina to negative from stable ― a warning that the South American country could face another downgrade.

Moody’s said a sharp fall in the government’s foreign exchange reserves, to $27.5 billion from $52.7 billion in 2011, increases the risk that Buenos Aires “may not meet its foreign-currency debt service obligations.”

It added that “an inconsistent policy environment” increases the likelihood that reserves will remain under pressure through 2015.

It said the country faces persistent capital flight and declining trade surpluses, which will further erode reserves, which the government must use to pay its bond holders.

In addition, confidence in the currency is falling in part because of the perception that the government is not addressing the other problems, Moody’s said.

“Argentina is one of the few Latin American countries with a capital account deficit due to persistent capital outflows and a lack of access to international debt markets,” Moody’s said.

“Lack of confidence in government economic policies, including one of the region’s highest inflation rates, will make it difficult to prevent continued capital flight.”

Moody’s pointed to the government’s incomplete reform stance, allowing the peso to sharply depreciate and float somewhat, but not taking action to cut huge subsidies that are draining expenditures.

A consequence is that the government will continue to print money to cover its shortfalls, Moody’s said, contributing to inflation.

Monday’s official inflation report showed a slightly slower pace of rise from January’s 3.7 percent monthly pace, but it was still much higher than the rate of the past two years.

It was the second month in a row that the government has used its new price index, generally seen as credible after years of under-reporting inflation.

Economy Minister Axel Kicillof linked the rising prices to “a lot of price distortion in January and February,” related in part to the effective devaluation of the peso after the central bank stopped intervening in the market for several days.

Moody’s meanwhile warned that policy ― higher interest rates and faster depreciation of the peso ― would hurt economic growth, further challenging the government’s ability to adjust policy.