Good news on inflation – 06/07/2023 – Vinicius Torres Freire

Inflation was at 11.7% per year in May 2022. It dropped to 3.9% in May 2023. “Per year”: inflation accumulated over twelve months. There is a bit of illusion in this low number. But there are indications that the IPCA could fall further and means to make inflation and expectations decrease, with government help in particular.

Thus, the reasons why the Central Bank maintains the Selic rate at 13.75% would fall off the radar.

There is likely to be no cut at the June BC meeting. Whether the Selic reduction will come on August 2nd or September 20th is not relevant to the progress of the economy, not even in the short term. Is it better to cut slowly, 0.25 percentage point from August, or go for a confident and regular cut of at least 0.5 point, from September?

It is better to create conditions for a quick cut. In the estimates compiled by the BC, private sector economists still predict Selic at a horrible 10% at the end of 2024; the most optimistic in the square predict 9%.

First of all, let me repeat that inflation of 3.9% per year up to May is a bit illusory. The IPCA account for these 12 months includes artificial disinflation, the 1.3% drop from July to September 2022, the electoral reduction in fuel prices by the government of darkness. Being optimistic, the IPCA ends this year around 5%.

In addition, free prices still rise 5.7% in 12 months. It is that inflation measure that disregards price changes that are somehow influenced by governments: water, electricity, fuel, public transport, tolls, health insurance, etc. Services inflation was 6.5% and is falling slowly.

But there is good news. Wholesale inflation has been plummeting. In the 12 months through May, the Wholesale Price Index (IPA, measured by the FGV) dropped 8.9%, largely thanks to iron ore, diesel, corn, soy and beef.

The price of the dollar has been behaving around R$4.9. GDP grows more than expected, but, for better or for worse, not in such a way as to put more pressure on inflation (household consumption is slow, almost stopping, and productive investment has dropped).

Inflation expectations for the next 12 months have dropped since April, albeit still at 4.7%. For 13 to 24 months ahead, they are down since mid-May, albeit by still 4.1%. However, the numbers are beginning to surprise downwards. The expectations of “the market” should also fall.

The perception of what Lula 3 will do with his accounts and deficits has deteriorated. It is possible that the government collects more than anticipated; it is possible to obtain smaller deficit. It won’t weigh heavily on general expectations, but it’s something — in favor. If the government puts an end to this talk of revising the Central Bank’s inflation target, it will gain a few points in inflation expectations (they will go down).

In the market where the costs of financing deficits and government debt are defined, interest rates have fallen well. The one-year futures rate was 14.6% in November 2022, as Lula rose to the podium to criticize public spending control (at the end of the election, the rate was at 13.2%). It was the biggest shot in the foot that the president has given since being elected. Now, the one-year rate is down to 12.2%, thanks in part to the fiscal framework, and is below the “Lula Day” level for all maturities.

However, as inflation expectations also lowered, the real interest rate rose somewhat (one-year futures rate minus 12-month inflation expectations). It was around 7% in April, it is now at 7.3%. A little extra monetary squeeze there.

There are reasons behind this drop in inflation; there are ways for the government to create additional conditions for a quick cut in the Selic rate. Hence, the responsibility rests with the BC.

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