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The downturn in economic activity, a
strengthening currency and successive hikes in interest rates are
beginning to lower inflation. The prospects for lower economic growth and
continued currency stability, in combination with the government’s
commitment to sound economic policy, makes monetary officials confident
that inflationary expectations will drop. |
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Inflation
moderating amid slowdown in economic activity and strengthening currency
The mid-June consumer price index (IBGE-IPCA 15), which covers monthly
price increases up to the 15th of every month, rose 0.22%. The June figure
came in well below the 0.85% monthly increase observed in May and
confirmed the emerging trend to lower inflation observed since March this
year. As a result of the modest June increase, annual inflation dropped
for the first time since August of last year from 16.9% in May to 16.7% in
June. The inflationary pressures resulting from last year’s currency
weakening and higher oil prices earlier this year are finally abating. In
its quarterly inflation report, published on 30 June, the Central Bank
says that the combination of a strengthening exchange rate and a slowdown
in economic activity is likely to lower inflation in the coming months.
According to the report, monetary authorities now see gross domestic
product (GDP) to grow just 1.5%, which is down from the previous Central
Bank projection of 2.2% growth. The Central Bank also adjusted its
inflation estimate downward from the earlier 10.8% to 10.2%%. Even though
the estimate remains well above the current 8.5% central inflation target
for this year, monetary officials remain optimistic about containing
inflation within the +/-2.5% band. Nevertheless, participants do not share
the Central Bank’s optimism, seeing inflation much higher this year.
Furthermore, inflation next year is also expected to exceed monetary
authorities’ stated target of 5.5%.
Central
Bank lowers interest rate amid inflation optimism
Despite the fact that inflation remains well above the current target,
authorities believe that the recent currency stability and more moderate
economic growth, if persistent, may give the Central Bank leeway to lower
interest rates. In June, the currency appreciated again – by 3.3% in
nominal terms versus the US$ - over the prior month, which represented the
fourth monthly strengthening this year and brought the currency
appreciation for the first six months of the year to 23.0%. In its 18 June
meeting, the Central Bank decided to lower the benchmark SELIC rate from
26.5% to 26.0% - the first cut since September last year. Monetary
authorities justified the monetary loosening with optimism about an easing
of inflationary pressures this year amid the more stable exchange rate and
lower economic growth. Consensus Forecast participants have revised their
interest rate forecast again this month, anticipating the SELIC rate to
drop moderately by the end of this year. In fact, panellists anticipate
the Central Bank to be able to lower rates again in the third quarter.
Furthermore, the easing of inflationary pressures will lower interest rate
further next year.
Government maintains fiscal discipline
The public sector incurred a primary surplus of 4.3 billion reais (US$ 1.5
billion), which was down from the robust 9.9 billion reais (US$ 3.2
billion) surplus in April. As a result, the public sector’s accumulated
primary surplus from January to May reached 37.0 billion reais (US$ 12.8
billion) in the first five months of this year. Consequently, Brazil
already exceeded the 34.5 billion reais (US$ 11.5 billion) deficit target
for the first semester agreed to with the International Monetary Fund (IMF)
under the terms of the US$ 30.7 billion stand-by agreement signed on 6
September last year. The government is now well on target to meet its
4.25% primary surplus target set for 2003. However, despite the positive
development in the primary fiscal balances, the overall fiscal balance,
which adds debt servicing costs, registered a 5.1% of GDP deficit in the
twelve months through May, up from the 4.9% of GDP shortfall observed in
April for the same period. Participants confide in the government to
follow a course of fiscal discipline and expect the fiscal deficit to drop
to 4.0% of GDP this year, which is unchanged from last month. The decision
of lawmakers to work through the July recess in order to progress on
needed pension and tax reform legislation, along with the IMF’s stated
interest to renew the current stand-by agreement that expires in
September, are likely to reinforce confidence in the current government.
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