Campos Neto: timely BC approach, slow disinflation – 05/17/2023 – Market

The proactive approach to monetary policy in Brazil was timely and has yielded results, but the process is now in a phase in which the reduction of inflation is slower, said this Wednesday (17) the president of the Central Bank, Roberto Campos Neto , emphasizing that Brazil faces challenges in consolidating disinflation.

In a videoconference presentation at the Central Bank’s Annual Conference, he emphasized that inflation expectations for 2024 and 2025, which were stable, show discouragement, with questions about a possible change in inflation targets and fiscal uncertainties.

Campos Neto stated that core inflation —which disregards volatile items— is more resilient due to a diffusion of high prices across sectors of the economy and still strong pressures on more rigid components, such as the services sector.

“Thus, the speed of disinflation tends to be slower in this second stage, both in Brazil and in other countries,” he said. “Although we have made progress so far, we still face challenges in consolidating disinflation in Brazil.”

According to the BC’s Focus bulletin, which captures market projections for economic indicators, inflation expectations are at 6.03% for this year, 4.15% in 2024 and 4% in 2025.

The established targets are 3.25% this year and 3% in 2024 and 2025, with a tolerance of 1.5 percentage points more or less in all cases.

Amid criticism by President Luiz Inácio Lula da Silva of the basic interest rate practiced by the Central Bank to control inflation, currently at 13.75% per year, the government began to study possible changes in the target system. The Minister of Finance, Fernando Haddad, has already signaled that he is in favor of extending the horizon for the targets, which would release the Central Bank from meeting them at the end of each year.

“Decisions that induce the re-anchoring of expectations and that raise confidence in the inflation targets contribute to a faster and less costly inflationary process”, stated Campos Neto.

The BC president once again stated that the fiscal framework proposed by the government of President Luiz Inácio Lula da Silva can help in the mission of reinforcing expectations, although there is no direct relationship between the fiscal proposal and the price level in the country.

In the presentation, Campos Neto stated that incidents at banks in the United States and Europe had raised attention to risks, such as the most widespread contagion in the financial system. According to him, so far, this contagion is limited, but requires monitoring.

IMF’s Gopinath sees “considerable” risks of rising inflation and says markets are too optimistic

The second-ranking official at the International Monetary Fund (IMF) said on Wednesday he saw considerable risks that inflation would remain high or accelerate in many emerging markets, and urged central banks to maintain tight monetary policies.

The IMF’s first deputy managing director, Gita Gopinath, told a conference organized by the Central Bank of Brazil that markets were probably “too optimistic” about what it would take to reduce inflation in emerging countries.

“Despite the encouraging signs, I am concerned that price pressures appear entrenched in many economies and that upside risks to inflation are considerable,” she said in prepared remarks.

“Central banks must remain steadfast in maintaining tight monetary policies and recognize that insufficient monetary tightening now may require even more painful actions in the future,” he added. That was a lesson learned in the high inflation period of the 1970s and “applies very well today,” Gopinath said.

She said fiscal restraint could support central banks’ fight against inflation and that financial tools could improve “trade-offs” in case of pronounced financial stress, if used judiciously.

Gopinath said emerging economies have maintained growth in recent years helped by strong monetary policy frameworks and reforms that have reduced credit and currency risks.

But those countries still face “considerable downside risks” from monetary policy tightening in advanced economies, and conditions could worsen “significantly”, she said. The rise in US interest rates, for example, took place under conditions that are still benign, but that could change in the future, she said.

Gopinath said she was less optimistic than markets about the reduction of inflation in emerging countries, as it has already been unexpectedly high and persistent and often rises faster than expected, according to her.

Services inflation has been strong and the tightening of monetary policies has not significantly cooled labor markets, with wage growth still robust in many emerging market economies, Gopinath said.

She said a number of factors could be contributing to inflation’s stubbornness, including pent-up demand from the pandemic, a shift in demand from goods to services and a reduction in potential output and employment.

Given the few historical precedents of inflation falling from very high levels without a significant economic slowdown, Gopinath said “fairly strong” labor markets and activity point to “considerable upward pressure on inflation”.

She said that companies could pass on higher costs rather than absorbing them into their profit margins, and that workers could demand correction of real wage losses. This means that the longer inflation remains high, the harder it will be to reduce it and the greater the contraction in output that will be needed to cool it down.

These challenges are global, but the risks are greater for emerging markets, Gopinath said, underscoring the need for authorities in these countries to continue strengthening their monetary, fiscal and financial policy frameworks.