Inflation should rise again in the second half; understand – 04/28/2023 – Market

The next two months will bring good news for the behavior of inflation, which should increase pressure from the Lula government for the Central Bank to anticipate the cut of the basic rate, the Selic, currently at 13.75% per annum.

The relief, however, will be temporary and occurs in an environment in which market expectations about the ability of the Central Bank to put inflation on target are unanchored 24 to 36 months ahead —as happened during part of the Dilma Rousseff government between 2011 and 2016.

Although the official inflation (IPCA) accumulated in 12 months has retreated to 4.65% in March —and, in the preview for April (IPCA-15), to 4.16%—, the so-called cores calculated by the BC are running well above from that.

One of the BC’s favorite cores, which eliminates 40% of the items surveyed with extreme variations (20% at each end of the distribution) and smooths out abrupt movements, closed March at 7.51%, almost 3 points above the IPCA. Called IPCA-MS, this is the core that comes closest, over time, to official inflation results.

In BC’s Focus survey, the market estimates that inflation in 2023 will be 6.04%, above the central target of 3.25% and the ceiling of this target (4.75%). If confirmed, it will be the third year in a row that Brazil exceeds the inflation target.

If food at home was the main inflationary factor in the last two years, until it started to slow down in 2023, the second half will be marked by greater pressure from administered prices (such as tariffs and fuel) and resistance to high interest rates in the services sector.

In the general composition of the IPCA, food has a weight of 13%. Services and administered prices account for 37% and 25%, respectively. Smaller or higher deceleration in these two groups, therefore, tend to make the fall in inflation slower.

In the case of services, which account for two-thirds of GDP and weigh most heavily on the IPCA, the indexation of many contracts by past (higher) inflation will continue to feed the future index.

“During the pandemic, indexation in contracts such as rents and school fees took a break. Now, it’s back with everything. This pushes past inflation into the present, delaying the fall in prices for services”, says Guilherme Moreira, coordinator of the Index of Consumer Prices (IPC) of the Institute of Economic Research Foundation of USP.

André Braz, coordinator of the IPC at the Brazilian Institute of Economics (Ibre) of the FGV, says that, in addition to indexation and the resistance of services to high interest rates, some administered prices should rise in the coming months.

In the case of fuel, on which the states will be charged, in July, the collection of ICMS on gasoline and ethanol. Estimates indicate an increase of almost 12% in the price of gasoline, with an impact of 0.5 points more on the 2023 IPCA.

Several states are also increasing the ICMS tax rate on energy to compensate for revenue losses during the tax change in 2022.

“The tax cut in the 2022 election race created a tremendous illusion, masking inflation. The bill comes this year”, says Braz.

In addition to the pressures on some groups of goods and services, specialists point to other factors, cyclical and structural, that may be behind the resilience of inflation, despite the burden of interest rates to cool the economy.

For the former president of BC Affonso Celso Pastore, there is an inflation of demand in the country, “without a doubt”, caused by the strong stimuli created by Jair Bolsonaro (PL) in the electoral cycle and still, in part, present.

In February, for example, the BC’s Economic Activity Index recorded growth of 3.32% in relation to the previous month. It was the highest rate since June 2020 (+4.86%). In services, the rate measured by the FGV rose in April to the highest level in five months.

“To bring inflation to target, monetary policy [efeito dos juros] would have to be much more restrictive. But, when the government criticizes the Central Bank, it ends up helping to unanchor expectations”, says Pastore.

“If it weren’t for that, the firm posture of the [Roberto] Campos Neto [presidente do BC] would be helping to bring inflation down. But, with everyone knowing the government’s opinion on interest rates, and Campos Neto leaving BC at the end of 2024 [quando termina seu mandato]where are inflation expectations going next year?”

According to a study by a team of economists, these expectations are already unanchored. That is, the market does not believe that inflation will fall to the center of the target in the 24 to 36 months ahead.

In the work “Determination of individual prices when expectations are unanchored”, the authors argue, based on research with the IPA (Wholesale Price Index, which involves around 2,000 companies), that entrepreneurs tend to pass on exchange rate variations to their prices much more vigorously, for example, when they no longer believe that inflation will reach the target.

“Inflation has been unanchored since mid-2021. When this occurs, there is a greater dispersion of expectations, with many more people betting on inflation above the top of the target, which makes it more difficult to control it in the months ahead”, says Silvia Matos, coordinator of the Ibre-FGV Macro Bulletin and one of the authors of the study.

Another problem pointed out by experts refers to the so-called neutral interest rate, a rate level that does not pressure and does not slow down inflation. In 2021, when interest rates began to rise, the BC calculated the neutral rate at 3% per year; today, it is estimated at 4%.

There are those who calculate it at 5%, mainly due to the rise in international interest rates and the increase in fiscal stimuli in many countries during the pandemic; in Brazil including, reinforced in the election.

Thus, discounting the inflation expectation and the higher neutral rate, the real interest rate (above price variation) would be today lower than many estimate. This reduces the power of the Selic, by 13.75% per year, in combating inflation.

“When inflation stays high for a long time, it takes time to fall, and needs a monetary restriction [juros altos] more intense and persistent”, says Livio Ribeiro, partner at BRGC consultancy and researcher at Ibre-FGV.

Ribeiro also recalls that a good part of the relatively positive numbers for inflation generated by the tax cuts in 2022 will soon start to come out of the calculation of price changes in 12 months.

“This dies in July. From then on, we will have worse numbers in the results in 12 months”, he says.