market believes government will change system

The National Monetary Council (CMN) meets next Thursday (29) under the expectation of a possible change in the inflation targeting system. The discussion is on the table about replacing the current target regime per calendar year with a model with a longer measurement horizon or continuous pursuit, as already defended by the Minister of Finance, Fernando Haddad.

A survey carried out with more than 100 managers, strategists and economists in the financial market pointed out that most of them believe that the system will really be changed (read more below).

“I think the continuous goal is much better than the calendar goal. You don’t have the Gregorian calendar, but you have the path you’re going to take [a inflação] reach 3% in a situation where you are not going to disorganize the national economy”, said the minister in early May, in an interview with CBN radio.

The initial objective of the meeting would be to define the inflation objective for 2026 and, if there is interest, an alteration of the numerical targets already defined for the years 2024 and 2025 could also be on the agenda – which today are 3%, with a tolerance band of 1.5 percentage points more or less. Although it is considered unlikely, the measure is not completely discarded by the government.

At the beginning of the year, President Luiz Inácio Lula da Silva (PT) criticized the current inflation targeting system several times, even defending raising the levels established for this and the coming years. He even spoke of a level of 4.5% for 2023, while the current target for inflation in 2023 is 3.25%, with a margin of 1.5 percentage points.

So that the goals already defined can be revised, the government would not have major difficulties. All that would be needed was a presidential decree authorizing the measure and approval by the CMN, currently made up of Haddad, the Minister of Planning, Simone Tebet, and the President of the Central Bank, Roberto Campos Neto. Favorable votes by the two Ministers of State would be enough for the approval of the measure.

A numerical change in the targets set for the coming years, however, would be a setback for the country’s economy, in the opinion of market analysts. “The government would be signaling that it wants the Central Bank to accommodate persistently higher inflation. And we know that to accommodate higher inflation, you want a loose fiscal policy”, says Gabriel Leal de Barros, partner and chief economist at Ryo Asset.

“If you raise the target, the market obviously projects a higher level [de inflação]. I think that the Central Bank, if the target were raised, would perhaps ask for more time to wait for changes in expectations before starting the interest rate cut cycle”, comments Gustavo Cruz, chief strategist at RB Investimentos. For him, with the maintenance of the current targets, it is likely that the Central Bank will start lowering the basic interest rate from August.

Market expectations for inflation in 2023 have been falling since the beginning of the year. Today, the midpoint of projections for the IPCA is 5.06% at the end of the year – a month ago, the median was 5.71%. In the same range, estimates for 2024 dropped from 4.13% to 3.98%, and those for 2025 dropped from 4% to 3.8%.

An eventual change in the targets could change this scenario. “The change in the target at this time when the Central Bank is managing to anchor expectations can, yes, lead to an upward change in expectations”, says Ricardo Pompermaier, chief strategist at Davos Investimentos.

“We always have to remember that higher inflation is more harmful to the most needy than higher interest rates, and that the Brazilian inflationary culture still resists, due to our past of hyperinflation”, he says.

Change in target calculation regime divides economists

The eventual change in the system for calculating the goals divides economists. Pompermaier, for example, welcomes the possibility.

“We think the discussion about changing the horizon of the target to cushion possible inflationary shocks is healthy”, he says. “Instead of looking at inflation in closed annual periods, the horizon for the pursuit of the target is broadened, which may soften the need for monetary policy shocks”, he adds, emphasizing that the practice is adopted in some countries.

Leal de Barros, from Ryo Asset, considers that the best decision by the CMN would be to keep the target system exactly as it is today. “There is shock [de preços] that needs more time, there are shocks that need less time. So this decision of how long the Central Bank will have to work to bring inflation to the target is a decision that should be made by the Central Bank itself”, he says.

For Nilson Teixeira, former chief economist at Credit Suisse in Brazil, an exchange does not make sense at the current moment. “The Copom’s response has been calibrated to ensure the achievement of the target within a period that does not cause an excessively negative impact on activity”, wrote the economist in the newspaper “Valor Econômico”.

“Thus, replacing IPCA inflation as a target with one of its cores or transforming this target into a continuous objective – instead of being considered just the calendar year – does not make sense at the current moment. In addition, the concept needs to be simple and easy for society to understand: the core and ongoing commitments are more abstract and difficult to understand,” he added.

To CNN Brasil, the Ministry of Finance declared that it was in favor of changing the horizon of the targets. The portfolio told the vehicle that, in the event of “exogenous shocks”, a continuous target would allow the BC to “use instruments available within the relevant horizon to direct expectations in a smoothed way”.

“In a recent assessment of Brazilian economic policy, IMF staff [Fundo Monetário Internacional] indicates the superiority of an arrangement with targets that are not linked to the calendar year and that are achieved within the relevant horizon of the monetary policy”, the ministry also declared in a note.

Most economists believe that CMN will change the inflation targeting system

A survey carried out by Warren Rena with 108 managers, strategists and other market economists at the end of May showed that only 11% of respondents believe in maintaining the target system per calendar year. For 48%, the current model will be replaced by the continuous target, while 41% foresee the adoption of medium-term moving average targets.

Among those who believe that the target per calendar year will be maintained, 50% expect numerical changes in the inflation targets for 2024 and 2025, while the other half believe in maintaining the current targets.

“By not making changes, the government itself would benefit”, says Leal de Barros. “Inflation expectations are higher, and interest rates are higher on the curve, because the market put the risk of some change in the price. If there is not, there is a tendency to reduce the implicit inflation in the curve”, he explains.

“For the government, which wants interest rates to fall so badly, this should be the optimal strategy: make no changes at all. But we have already seen several decisions that the government has taken that are not rational”, she evaluates. “As it is very obvious that doing nothing is the best thing, but this issue remains on the table, the government sends a signal that it still has a hidden interest in making some change.”

For Gustavo Cruz, from RB Investimentos, who considers the level of the current inflation targets to be fair, there are ways to discuss changes without prejudice to market expectations. “Going out criticizing the BC president, what is being done, stimulating protests, is not the best way”, he says.

“Promoting forums, bringing debates, suggesting this, but in a conciliatory way, that’s something more tangible. Perhaps if management had been more friendly, it would not have taken so long to cut interest rates”, he adds.