Despite deflation, consumer price index also delivered some bad news for the country’s monetary policy
09/11/2024
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Central Bank’s building in Brasília — Foto: Cristiano Mariz/Agência O Globo
In August, inflation posted its first decline of the year, moving away from the upper end of Brazil’s Central Bank target and potentially easing some pressure on the upcoming Selic policy rate hikes that the Monetary Policy Committee (COPOM) is expected to implement next week. Nevertheless, the outlook for guiding the Central Bank’s policy rate remains challenging.
According to the Brazilian Institute of Geography and Statistics (IBGE), Brazil’s official inflation rate (Broad Consumer Price Index, or IPCA) fell by 0.02% in August. This marks the first decline in nearly two years and came in below both market expectations (a 0.01% increase, according to Valor Data) and the Central Bank’s forecast (a 0.07% gain, as per the latest Inflation Report). More significantly, the 12-month rate dropped from 4.5%—at the upper limit of the target—to 4.24% between August and September. Following the release, future interest rates fell, with traders now expecting a lower chance of a 50-basis-point increase and a higher probability of a 25-basis-point hike in the Selic rate next week.
One bright spot was the slight decrease in the average of the five core inflation indicators tracked by the Central Bank, which fell from 3.83% to 3.8%, according to MCM Consultores. Core measures exclude more volatile items and thus offer a clearer picture of inflation trends relevant to monetary policy and economic activity.
There also appears to be reduced pressure on underlying service prices, which are closely tied to monetary policy. Itaú Unibanco’s economic team estimates that the seasonally adjusted and annualized three-month moving average declined from 6.2% to 5.6%.
However, the IPCA also revealed some less favorable news. The diffusion index, which measures the percentage of items with rising prices, jumped from 46.9% to 56%. Excluding food items, which are more volatile, the indicator rose from 53.1% to 61.7%.
Itaú highlights that, while service prices showed some improvement in August, they are expected to face “some pressure” in the coming months, potentially ending the year with an increase “close to 5.5%.”
The IBGE said that strong labor market performance and overall economic activity may influence trends in service prices.
Recent data includes the IBGE’s report that GDP grew by 1.4% in the second quarter compared to the previous three months, surpassing the median projection of 0.9% from economists at financial institutions, asset managers, and consultancies surveyed by Valor Data.
The pre-COPOM survey released last week indicates that the Central Bank is focusing on economic slack, which is directly influenced by GDP and the labor market, and its impact on inflation. The survey now asks private sector economists about their projections for the output gap, a question not included in June’s survey.
Banco ABC Brasil also notes that, over the longer term, core inflation measures generally “support the outlook of a slowing domestic disinflation.” Banco Bradesco’s estimates show that “core inflation is running close to 4.5% on an annualized three-month basis,” about “1 percentage point higher than in the second quarter of the year.” There are also concerns about how the drought might affect food prices in Brazil.
To manage the Selic rate, currently at 10.5% per year, the COPOM is targeting the first quarter of 2024, forecasting inflation of 3.4% in a reference outlook and 3.2% in an alternative one. In both cases, according to the Central Bank’s own terms, the rate is “above” the 3% target.
Since at least the first quarter of last year, the COPOM has been warning, both in official communications and in statements from its members, about the challenges of the “second stage” of post-pandemic efforts to bring inflation to target. On Monday, the median market projection for the Selic rate, according to the Focus Bulletin, increased from 10.5% to 11.25% by December and from 10% to 10.25% by the end of next year.
The committee will once again meet under challenging conditions next Tuesday and Wednesday to decide on the base interest rate. This stands in contrast to the upcoming Federal Reserve meeting, where the Fed is expected to start an easing cycle, having kept its policy rate between 5.25% and 5.5%—the highest level in over two decades—for just over a year.
*Por Estevão Taiar, Valor — Brasília
Source: Valor International