Expectations for GDP, inflation worsen due to floods in Rio Grande do Sul, Brazil’s fiscal situation, U.S. interest rates

05/21/2024

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Sérgio Vale — Foto: Claudio Belli/Valor

A series of negative news and emerging risks have formed a mix that has worsened economic agents’ expectations for the economy in 2024 and 2025. The latest sign of this process is the market’s median projection for 2024 GDP growth, which fell for the first time in almost a year this week.

Analysts say the scenario pressures the Central Bank to adopt a more cautious stance on interest rate cuts. However, some also see these movements as somewhat exaggerated.

According to the Central Bank’s Focus survey, the market’s median projection for 2024 economic growth dropped to 2.05% from 2.09%. This is the first decline in the projection for this year since June 16 of last year, when it fell to 1.20% from 1.27%.

Meanwhile, the median for Brazil’s official inflation index IPCA rose to 3.80% from 3.76%. For 2025, inflation expectations increased to 3.74% from 3.66%. The median projection for the Selic policy rate rose to 10% by the end of 2024 from 9.75%.

“This worsening of expectations is not new. It started with the changing outlook for U.S. interest rate cuts and growing concerns about Brazil’s fiscal scenario. But it was accelerated by the rift within the Central Bank’s board at the last Monetary Policy Committee (COPOM) meeting and now by the tragedy in Rio Grande do Sul,” said Sérgio Vale, chief economist at consultancy MB Associados. “This last factor directly impacts growth prospects for 2024 and also inflation, as analysts are already incorporating short-term shocks in food prices. These events have halted the previously improving projections for economic activity.”

The scenario is almost a “perfect storm”—but, according to him, “one created by the government, which bears significant responsibility for the poorly calibrated fiscal outcome since the fiscal framework, exemplified by the change in the primary target for 2025,” he said. “This spills over into problems like the one in Rio Grande do Sul, where the situation demands a level of aid that public finances are not prepared to provide.”

“There is indeed an environment of deteriorating expectations, which became more evident with the Focus survey. It was the third consecutive week of an increase in the IPCA median for next year, which is the Central Bank’s main focus,” said Silvio Campos Neto, a senior economist and partner at Tendências Consultoria.

He also highlighted the split within the Central Bank’s board regarding the pace of interest rate cuts, which has crystallized doubts that have existed since the end of last year about how the monetary authority will act with the change in leadership. “It is more than natural for the market to be uncertain due to high political signals and pressures towards a more interventionist approach, as seen in the Petrobras leadership change episode or attempts to boost economic activity using state-run companies in a context of low economic slack.”

Fabio Romão, a senior economist at LCA Consultores, calculates that the recent worsening of projections for 2024 and 2025 inflation in the Focus survey is concentrated on free prices within the IPCA. While the 2024 projection rose to 3.72% from 3.67%, the 2025 projection increased to 3.68% from 3.57%.

“We believe this increase in expectations for 2024 and 2025 is related to currency depreciation and uncertainties in the pricing of certain food items—following climatic events in the South,” he said. The consultancy raised its estimate for food-at-home inflation in 2024 to 4.5% from 3.9% but kept the 2025 estimate at 4.9%.

For 2025, Mr. Romão expects a moderate acceleration in regulated prices after the municipal elections. Another source of pressure could be the resumed rise in industrial goods prices, which have been contained since 2023, he added.

Silvia Matos, coordinator of the Macro survey at the Brazilian Institute of Economics of the Getulio Vargas Foundation (FGV Ibre), said that the current expectation scenario calls into question the quality of future economic growth.

“When the fiscal policy is more expansionary, the economy ends up with much higher real interest rates to keep inflation lower. This signals a higher risk premium, and the cost of rolling over public debt also rises. It’s the worst of both worlds—high disinflation costs in terms of activity,” she said.

Given this scenario, economists believe the monetary authority will need to be more stringent in its message about combating inflation, which may include rethinking the final stretch of the interest rate cut cycle. However, they also note that uncertainties surrounding the Central Bank’s leadership change hamper this process.

“Today, there is a fear that the Central Bank will lower its guard on reducing interest rates. If this concern grows, medium- and long-term interest curves will rise significantly. This increases debt costs and affects economic activity because the cost for companies to invest will be higher,” said Mr. Campos Neto, with Tendências.

Despite predominantly negative news, some urge caution in analyzing the worsening expectations scenario. One reason is that, although uncertainties have increased, current economic indicators still allow for some optimism.

“I believe some concerns are natural at this stage of the cycle, in which growth comes more from demand, particularly from a labor market that continues to surprise and raises questions about future inflation behavior,” said Cristiano Oliveira, chief economist at Banco Pine. “But at the same time, I see some exaggeration. There seems to be a contradiction in increasing expectations for both the Selic rate and the IPCA in the medium term. Even working with a higher real interest rate than the Central Bank, as we do, it is only logical to assume that only one side [inflation or interest rates] will be correct, not both.”

For Mr. Oliveira, the floods in Rio Grande do Sul will have a greater impact on activity than on inflation. The unanchoring attributed to food prices may disappear, as it is temporary and other prices remain controlled. However, the damage to activity will be more significant, he said. “Much is expected from the fiscal stimulus, but I have my doubts. We must consider that even the government’s aid of R$5,100 [per affected family] is small to recover entire lives and businesses that have been closed.” The market reacts to uncertainties and is right to demand a higher premium for it, but it is not necessarily correct about what will happen, he added.

*Por Marcelo Osakabe, Marsílea Gombata — São Paulo

Source: Valor International

https://valorinternational.globo.com/