Arquivos inflation scenario - Murray Advogados

Monetary authority is excessively optimistic compared with projections of private-sector analysts

07/08/2022

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

A survey carried out by the Central Bank with economic analysts before the last policy meeting, in June, and released Thursday morning puts at stake the inflation scenario outlined by the monetary authority, which is excessively optimistic compared with the projections of private-sector analysts.

In the June meeting, the Central Bank’s Monetary Policy Committee (Copom) projected a 4% inflation rate for 2023, the year that until then was the main target for monetary tightening. But the survey carried out days before the meeting shows that few market analysts think this is possible.

The median inflation projection for 2023 collected in the survey with 99 segments of the financial market, was 4.7%, as already unveiled by the Copom in its minutes. But now the survey reveals how the view of analysts is distributed around this median.

The first quartile of projections, that is, the group of most optimistic analysts, pointed to an inflation rate of 4.33%. In other words, less than a quarter of the analysts thought it was possible for inflation to stay below 4.33%. The highest quartile pointed to inflation of 5.1%.

In the June meeting, the Copom concluded that the balance of risks surrounding to inflation was symmetrical. That is, the upside risks to inflation, in relation to what was projected, were balanced with the downside risks.

This is a very different view from that expressed by financial market analysts: 76% identified predominant upside risks in their inflation projections for 2023, while 19% considered the risks balanced.

The divergence between the Central Bank’s and the financial market’s inflation projections, as well as the distinct views on the balance of risks, have repercussions on the credibility of the monetary policy strategy outlined by the Copom.

In practice, Copom is stating, based on its projections, that it will be possible to reach the inflation targets in 2023 without many additional hikes in the key interest rate, which in June was raised to 13.25% per year from 12.75% per year. The policymakers indicated a new hike for August, to 13.5% or 13.75%, and the maintenance of higher interest rates for longer.

The market’s consensus scenario for the economic slack is also more conservative than the Copom’s. The committee projects economic growth this year of 1.7%, higher than the 1.5% then expected in the median of market projections. Even so, the Copom thinks that economic slack will be higher at the end of this year, at 1.8%, compared with 1.5% expected by the market. The greater the slack, technically measured by the output gap, the greater the disinflationary force.

Since the slack estimated by the Central Bank and the market are very similar for the first quarter of this year, at 1.1% and 1%, respectively, the Copom is possibly estimating a higher potential GDP than the market – that is, the Central Bank would have a slightly more optimistic view than the market about how much the economy could grow without pressuring inflation.

Historically, the inflation scenario outlined by the Central Bank was not very different from that estimated by the financial market, but in the last year this divergence has widened. The monetary authority has been systematically projecting lower inflation than the market.

Normally, the inflation projected by the Central Bank diverges less than 0.3 percentage points from that of the market, for the relevant horizon of monetary policy. Last March, this divergence rose to 0.6 points and, as of May, to 0.7 points.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/

In practice, this reflects stronger GDP expansion and lower-than-expected unemployment rate

07/01/2022

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

It was not only supply shocks and other surprises that made the Central Bank revise upwards its inflation projections. There were also the impacts of the lower-than-estimated degree of economic slack and the higher neutral interest rate, according to the Inflation Report released by the monetary authority Thursday.

Since March, the Central Bank increased its inflation projection for 2022 by 2.5 percentage points to 8.8%. A good part of this increase is due to the war in Ukraine, which has caused the prices of oil and other commodities to surge and disrupted production chains due to China’s zero Covid policy.

But the revision in the inflation projections, to some extent, is due to the fact that the Central Bank overestimated the degree of economic slack at the beginning of the year.

In March, the monetary authority had estimated that the so-called output gap, a measure of the economic slack, would be 1.8% at the end of the first quarter. Thursday’s Inflation Report redoes this calculation and finds that, in fact, the slack was 1.1%.

From the point of view of the real sector of the economy, this is good news. In practice, it reflects stronger GDP expansion and a lower-than-expected unemployment rate. The Central Bank has increased its estimate for GDP in 2022 to 1.7% from 1%. But on the other hand, this means that economic slack has not been as strong a driver of lower inflation as expected.

In the second quarter, another surprise: the Central Bank estimated the economic slack at 2%, but according to the most recent estimate in Thursday’s report, it has been revised downwards to 1.3%. A good part of the consequences of this lower-than-expected slack is still expected to reach inflation, which reflects the output gap with a few quarters of delay.

Economic activity was stronger than expected, in part due to the reopening of the economy with vaccination and a lower number of deaths from Covid. But GDP data for earlier this year also reflect last year’s still expansionary monetary policy and fiscal expansion measures.

Another factor that contributed to increasing Central Bank’s inflation projections was the revision of the neutral interest rate. In its June meeting, the Central Bank’s Monetary Policy Committee (Copom) increased its view on the neutral interest rate to 4% from 3.5%.

The market had already revised its estimates to 4% by the end of 2021, due to the high fiscal risk amid tax-cutting measures and spending expansion during the election. But the Central Bank made the move in two stages, raising it to 3.5% from 3% in December, and now to 4%.

A consequence of this is that the economy has seen, before the revision of the neutral rate, a monetary tightening lower than the one estimated by the Central Bank. The monetary tightening represents the difference between the real interest rates forecast by the market and the neutral interest rate.

In Thursday’s Inflation Report, the Copom says that the monetary tightening is lower than previously estimated, in March, until the first half of 2023, precisely because the neutral rate has risen. The tightening is higher in the second half of 2023, because the market now expects a higher Selic policy interest rate for the period.

In practical terms, this higher neutral interest rate leads to a higher inflation projection not only for 2022, but also for next year, which is the relevant horizon for monetary policy. The Central Bank has revised its inflation projection for 2023 by 0.9 percentage points, to 4%.

The Inflation Report says that other factors have also contributed to the rise in projected inflation this year, such as rising inertia and deteriorating inflation expectations. Inertia and expectations, in turn, may have been affected by inflationary surprises and higher price indexes in the short term. But they are also determined by the degree of monetary tightening and the level of economic slack, as well as fiscal uncertainty.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/

Posts

Analysis: Central Bank’s survey calls into question inflation scenario

Analysis: Central Bank’s inflation scenario affected by economic slack