There have been a number of positive factors in recent weeks, making it difficult to pinpoint exactly what is behind the decline in longer-term expectations
Central Bank’s building in Brasília — Foto: Cristiano Mariz/Agência O Globo
The decline in long-term inflation expectations bodes well for the Central Bank’s Monetary Policy Committee (Copom), which meets next week to decide on the target for the economy’s key interest rate, known as Selic.
Data from the Focus bulletin – a weekly survey with analysts – released Monday show that financial market inflation expectations for 2025 and 2026 have fallen to 3.9% from 4%. For 2027, expectations are even lower at 3.8%.
Inflation expectations for such long horizons are a barometer of the credibility of monetary and fiscal policy, as well as the financial market’s reading of the level of inflation that the Lula administration will pursue.
The median expectation for 2025, at 3.9%, is still very high, considering that there is already a defined target of 3% for that year. But it is a good sign that there has been a slight decline, after a deteriorating trend since the beginning of the Lula administration.
There have been several positive factors in recent weeks, so it is difficult to determine exactly what is behind the decline in longer-term expectations.
One factor was the positive surprise in May’s IPCA, which is Brazil’s official inflation index. In theory, current inflation should not affect long-term expectations, but in practice it often does, as analysts tend to form their long-term view based on short-term data.
Also contributing to the decline in long-term expectations may have been signals from the government that it does not intend to raise the long-term inflation target, which was set at 3% at a meeting of the National Monetary Council (CMN) this month. Another positive factor was the good progress made in Congress on the new fiscal framework, even though it does not prevent the public debt from increasing in the coming years.
Another fact that may have contributed positively was the more conservative signals given by the Central Bank in the conduct of monetary policy, with indications that it would keep interest rates high for a longer period of time and even that it could raise them if the inflation scenario did not develop as expected.
The decline in inflation expectations is good news for the conduct of monetary policy, as the market’s inflation expectations are an important input into the Central Bank’s own forecasting models.
Today, the Central Bank’s inflation projections indicate that there is no foreseeable horizon for interest rate cuts. But if market expectations continue to fall, the Central Bank’s projections could improve to the point where interest rates could be cut sooner than was thought just a month ago. Today, the key rate is set at 13.75% per year, and the market’s median bet is that it will fall to 13.25% per year in September.
There are other positive signs in the Focus bulletin. One is that the market’s inflation expectation for 2024 has fallen to 4.04% from 4.12%. This is the year that currently carries the most weight in the Central Bank’s monetary policy decisions.
Market specialists also lowered their expectations for services inflation this year, to 5.87% from 6.01%, and for next year, to 4.91% from 4.95%.
They are still high, with targets of 3.25% in 2023 and 3% in 2024, but it is a sign that the market believes that the recent surprise in inflation points to a more sustained downward movement, and not just to benign swings in food and industrial goods prices.
However, it is still too early to say with certainty that the downward trend in long-term expectations will solidify in the coming weeks. The analysts who have updated their forecasts in the last five days reported a percentage of 3.9% for both 2025 and 2026.
The average expectation, on the other hand, has never reached 4%. Last week, it dropped slightly to 3.88% from 3.91% for 2025. The decline in the forecast for 2026 was a bit more pronounced, to 3.81% from 3.86%.
A lot will depend on whether the inflation indexes remain positive in the short term and on the decision that the CMN will take at the end of the month on the inflation target for 2026.
*Por Alex Ribeiro — São Paulo
Source: Valor International