Projections for the shorter term continue to deteriorate, driven in large part by the prospect of higher fuel prices
Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo
Inflation expectations in the financial market have deteriorated again just days before the meeting of the Central Bank’s Monetary Policy Committee (Copom), which will unveil its decision on Wednesday.
The trend of deteriorating inflation projections for shorter terms continues, mainly driven by the prospect of higher fuel prices. In longer terms, fiscal uncertainty and the noises generated by President Luiz Inácio Lula da Silva’s remarks on a possible revision of inflation targets are weighing.
In one week, the measured forecast by economic analysts for inflation in 2023 rose to 5.74% from 5.48%. Part of the increase is due to the likely end of the federal gasoline tax holiday in March. The reopening of China’s economy also tends to put more pressure on oil prices. The forecast for regulated prices rose to 8.39% from 7.25%.
However, this deterioration in short-term inflation, however, is unlikely to have a significant impact on the conduct of monetary policy. From this meeting on, the Copom will focus mainly on the 2024 inflation target. Policymakers have stated that they are focusing on inflation six quarters ahead, that is, inflation up to September 2024. By then, most of the pressure on regulated prices is likely to have dissipated.
The point is that inflation expectations for 2024 are also deteriorating. During the week, they went to 3.9% from 3.84%. At the last Copom meeting in December, it was 3.5%, already above the target of 3% for the year.
This worsening of expectations in the so-called relevant horizon for monetary policy – in other words, the period in which the Central Bank proposes to achieve the target – creates an additional constraint for the conduct of monetary policy. But one must not exaggerate. The Central Bank’s decisions are based on policymakers’ projections. The Central Bank usually reacts with further monetary tightening if its projections show a statistically relevant deviation from the target.
It is very likely that the monetary authority will keep its own estimates below the market. In December, the Copom projected inflation at 3% for 2024, below the market’s estimate of 3.5%.
The deterioration in market inflation expectations is expected to weigh on the Central Bank’s own projections. On the other hand, the Central Bank asked for market estimates of the expected fiscal expansion in 2023. According to the December survey, public spending is expected to increase by R$140 billion above the cap.
The Central Bank, on the other hand, does not have many additional reasons to raise its inflation projections for 2023, since its scenario already includes the expiration of the tax cuts. As a result, one should not expect much more inflationary inertia in 2024.
But there are factors that point in the opposite direction: the exchange rate has appreciated since December. In addition, the interest rate level used in the Central Bank’s forecasting model is likely to be much higher.
The Central Bank feeds its projections with market expectations for the Selic, which is Brazil’s key interest rate. In December, the start of the reduction cycle was expected for August. Now, for November.
In other words, thanks to the exchange rate and the monetary tightening that occurs within the model itself, even with the short-term Selic at current levels, the Copom may be able to present a somewhat stable inflation projection for 2024.
One should also keep in mind that the Central Bank looks carefully at other factors in making its decision. There is a component that looks backward, not just forward. The Copom has been looking carefully at the evolution of services inflation and the economic slack.
The question is how the Central Bank will deal with the deterioration in the market’s perception of fiscal risk and the risk of a change in the inflation targets, which has raised the experts’ longer-term projections. The median projection for 2025 was unchanged at 3.5% last week, and expectations for 2026 rose to 3.5% from 3.47%. At the December meeting, they were close to 3%.
Strictly speaking, these years are too far away to affect the most immediate conduct of monetary policy. But they are a very strong warning about fiscal risks. If the Central Bank were to say that fiscal risks to inflation predominate, this would theoretically require more action on interest rates.
But that seems unlikely, at least in the short term. The Central Bank has advocated calm in its assessment of fiscal risks, so one should not expect a clear warning. As for President Lula’s remarks about a possible change in inflation targets, Central Bank President Roberto Campos Neto tried to pour oil on troubled waters by saying that there were distortions in relation to what was said.
Moreover, fiscal risk is not the only news lately. The exchange rate has fallen, despite all the market fears about the public accounts, due to a more favorable international scenario than expected. The reopening of China is boosting commodity prices, and the scenario for activity and inflation in the developed world seems less gloomy.
In the past, under Ilan Goldfajn, the Central Bank liked to see the fiscal risk in its international context. The message at the time was that what was really worrying was the combination of fiscal risks with the international environment for emerging markets.
*By Alex Ribeiro — São Paulo