|
TThe spike in inflation observed at the
beginning of the year appears to have been left behind, which has
encouraged the Central Bank to lower interest rates and adopt further
monetary policy measures to spur on the ailing economy. While the external
sector is proceeding favourably, domestic demand continues to feel the
effects of a tight credit setting and a weaker exchange rate. |
|
Inflation moderating amid slowdown in economic activity and strengthening
currency
In July, consumer prices rose 0.2%. The July figure was above the 0.15%
monthly decline observed in June but was well below market expectations
and confirmed the emerging trend to lower inflation observed since March
of this year. An upward adjustment in regulated prices, particularly
electricity tariffs in São Paulo and telephone rates nationwide, was the
key driver behind the July consumer price increase. The more moderate
increases in fuel and food prices were insufficient to affect the upward
pressure of regulated prices. As a result of the July increase, annual
inflation dropped for the second consecutive month - from 16.6% in June to
15.4% in July. Inflationary pressures, induced by depreciation and higher
oil prices, finally appear to have been left behind. The current decline
in inflationary expectations is the result principally of the strong
appreciation in the currency observed in the first six months of this
year. The Central Bank anticipates that the current slowdown in growth -
gross domestic product (GDP) is seen as expanding just 1.5% this year -
and greater currency stability will help contain inflation further.
Monetary officials expect inflation to exceed the current 8.5% central
inflation target for this year but see inflation contained within the
+/-2.5% target band. Panellists are less optimistic about inflation
prospects, expecting a much higher rate of 10.7% for this year.
Furthermore, inflation next year is also expected to exceed monetary
authorities’ stated target of 5.5% with the figure more likely to come in
at 6.9%.
Central
Bank cuts benchmark rate amid more favourable inflation prospects
At its monthly meeting on 23 July, the Central Bank decided to lower the
benchmark SELIC interest rate by 150 basis points to 24.5%. The July
interest rate cut followed upon a more moderate 50 basis point cut in June
and confirmed that monetary officials are confident that the inflation
bout observed at the beginning of the year has been left behind. The rate
cut should help bolster the fledgling economy, which has seen activity
slow notably in recent months. Participants see the SELIC rate dropping
further this year to close at 20.9% by year-end. This month’s figure is
0.7 percentage points below last month’s. According to the Consensus,
monetary authorities are seen easing the monetary reins further next year,
bringing down the SELIC rate to 15.9% in 2004.
Currency weakens amid
new Central Bank measures
The real depreciated 3.1% in July, the highest monthly depreciation. The
July weakening contrasted with the 3.3% appreciation observed in the
previous month. Despite the depreciation in July, which brought the
exchange rate to 2.96 reais to the US$, the currency remains 19.2%
stronger than at the end of last year. Given that domestic demand has
remained subdued in the first half of the year, the external sector is
currently the only growth engine behind the economy. Officials remain
concerned that additional strengthening may erase the competitiveness
gained in the wake of the depreciation. The improved inflationary outlook
has encouraged the Central Bank to adopt additional monetary measures to
spur the lagging domestic economy. In July, the Central Bank eased
monetary restrictions to enable banks to increase their US$ holdings and
cut bank reserve requirements on checking accounts from 60% to 45%.
Participants expect the currency to depreciate an additional 9.8% this
year from July levels to close the year at 3.19 reais to the US$ - an
annual appreciation of 10.7%. Currency stability will persist into next
year with the real expected to reach 3.42 to the US$ by the end of 2004.
Government complies with IMF fiscal targets
The primary government surplus reached 3 billion reais (US$ 1.0 billion)
in June, which was up from the 4.3 billion reais figure observed in May.
The June figure raised the accumulated primary surplus for the first six
months of the year to 40 billion reais, which was well above the 28.9
billion reais figure registered for the same period last year. The strong
first half performance enabled authorities to over comply with the
accumulated primary surplus target for the first six months of the year
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.
As a result, the government remains well on target to complying with the
4.25% primary surplus target set for the year as a whole. Participants
remain confident that the government will stay the course of fiscal
discipline throughout this year, expecting the fiscal deficit to narrow to
3.9% of GDP by year-end. Nevertheless, the pension reform bill that was
approved by the lower house of the legislature on 7 August will prove key
to any further improvement in fiscal management. The approval of the bill
in the lower house is considered major success for the Lula
administration, as measures to tax civil servant pension benefits and cap
the judiciary pensions were included. Even though final approval requires
two additional Senate votes and one more Assembly vote, confidence in the
government’s ability to persuade legislature is high. If approved, the
pension reform should pave the way for significant savings in public
accounts and more sustainable fiscal balances over the medium-term.
|
