Contagion by past rate grows with official inflation at 10%, study shows

08/22/2022

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Daniel Karp — Foto: Carol Carquejeiro/Valor

Inertial inflation is expected to strengthen in the coming months and start losing momentum only by February, according to a study by economists Daniel Karp and Felipe Kotinda, with Santander. Inertial inflation is the phenomenon by which past inflation feeds future inflation.

The current discussion in Brazil on the subject began last year, when price indices started to rise rapidly after the most severe period of the pandemic. Considering 12-month inflation readings, the Extended Consumer Price Index (IPCA), Brazil’s official inflation index, has been above 10% since September 2021.

“A major part of the discussion [about inflation] is focused on how commodity prices, exchange rates, inflation expectations, and the output gap [a measure of economic slack] will drive the disinflation process,” the economists wrote.

“However, inertia plays an important role in inflation dynamics and is usually an overlooked driver,” they wrote. They also point out that in emerging countries inertia is “particularly” more important for price-setting policies than in developed countries.

Santander’s economists have created their own indicator to outline the scenario for inertial inflation. According to them, although it is used as a kind of proxy for inertial inflation in Brazil, services inflation does not include items that also have a high connection with the previous variation of prices, such as health insurance. Thus, services account for almost half of the lender’s indicator, but industrial goods, food at home, and regulated prices also enter the calculation.

According to Santander’s calculations, in July this year, the 12-month indices of services and inertial inflation were 8.88% and 9.51%, respectively.

The economists project that the trajectory of services prices will be around 9% until April next year. On the other hand, the inertial inflation indicator should “continue rising until a peak of 10.3% in February 2023.” “By the second quarter of 2023, we expect both will decelerate, both ending 2023 at around 6.3%.”

In the 12 months through July, the IPCA stood at 10.07%. Currently, to conduct the key interest rate Selic, the Central Bank must pursue the inflation targets for 2023 (3.25%) and, to a lesser extent, 2024 (3%). In both cases, there is a tolerance range of plus or minus 1.5 percentage points. But to “smoothens out the primary effects from tax changes” made by the federal government and Congress, the Monetary Policy Committee (Copom) has decided at the meeting earlier this month “to emphasize the projections for 12-month inflation in the first quarter of 2024.” For this period, the monetary authority projects a price trajectory of 3.5%.

In its latest minutes, the Copom said that “the components more sensitive to the economic cycle and monetary policy, with higher inflationary inertia, continue above the range compatible with meeting the inflation target.”

*By Estevão Taiar — Brasília

Source: Valor International

https://valorinternational.globo.com/