Higher than Expected Inflation May Not Affect Economists’ 2020 Interest Rate Projections

RIO DE JANEIRO, BRAZIL – The year 2019 interrupted a two-year sequence of the Broad Consumer Price Index (IPCA), Brazil’s official inflation, below the 4.25 percent target set by the National Monetary Committee (CMN). In 2019, the index stood at 4.31 percent, the highest since 2016, when inflation stood at 6.29 percent.

In December, the 1.15 percent hike was the highest for the month since 2002, when the rate rose 2.10 percent. Considering all months, the December IPCA was the highest since June 2018, when the truckers’ strike led the index to a 1.26 percent rise.

However, despite the result, most economists did not change their projections for inflation for the year or for the SELIC (Basic interest rate), while forecasting a slowdown in prices in 2020. Furthermore, the evaluation is that the above-expected 2019 inflation result should reinforce the cautious approach taken by the Central Bank on the upcoming interest rate decisions.

The meat price shock was responsible for much of the official inflation result both in December and at the close of the year. If it were not for the sharp rise in meat prices (18.06 percent in December alone), the IPCA would have stood at 3.54 percent in 2019. In other words, well below the target.

Thus, since this is a one-off event, reflecting the increase in exports to China due to the swine fever that has plagued the Asian giant and ultimately affected prices in Brazil, the concern over the acceleration of prices is not significantly affecting economists’ analyses.

“The core areas, which demonstrate the inflation trend, continue to behave well, with a variation of approximately 2.5 percent. In January, we expect the dispersion of an important part of the high meat shock, with no signs of contagion from the cores, thus strengthening the anchoring of inflation,” says Bradesco. For 2020, Bradesco’s projection is for an IPCA of 3.6 percent.

Goldman Sachs also evaluates that the still-high unemployment, well-anchored inflation expectations and reduced prospects for real GDP growth in the short term should contribute to keeping inflation steady, in their opinion. Low basic services inflation should also provide a more comfortable scenario for the Central Bank.

However, the COPOM (Monetary Policy Committee) points out that it should carefully analyze upcoming economic data in order to determine whether the cost-benefit of additional and moderate cuts in the SELIC (currently 4.5 percent per year) is justified, says Alberto Ramos, Goldman’s Latin American economist.

Among themselves, economists have different views on the Central Bank’s next steps on the SELIC this year, after constant cuts. However, many experts say there is still room for marginal interest rate cuts.

Morgan Stanley points out that although the core inflation rate has increased from three to 3.1 percent, it is still far from being a concern for monetary policy formulas. With this in mind, the bank’s economists believe that the Central Bank is comfortable following its cycle of flexibilization and should cut interest rates by 0.25 percentage points in the next COPOM meeting on February 5th.

Along the same lines, Bradesco believes that inflation should decelerate in January and thus continue on a positive path, maintaining room for the COPOM’s expansionist policy. “We believe that there is room for an additional interest rate adjustment to 4.25 percent, recognizing that the Central Bank may adopt a more cautious stance in this stage of the recovery cycle, and given the current level of real interest rates,” he pointed out.

XP Investments reinforces that, despite the higher than expected result reinforcing the cautious stance adopted by Central Bank regarding its next interest rate decision, the consensus is that Central Bank still has room to make another 0.25 point cut in the SELIC. In the same vein, JPMorgan also foresees a cut of this magnitude by the Central Bank.

With a discouraging view, Credit Suisse points out: higher inflation in December and the recent improvement in economic activity indicators should reduce the Central Bank’s probability of following its monetary loosening policy. Thus, the Swiss bank’s economists maintain their forecast for the SELIC to remain stable at 4.5 percent over the year 2020.

It is worth noting that the median of the projections in the latest Focus report, released every Monday by the Central Bank, pointed to the maintenance of the SELIC at 4.5 percent per year.

Thus, keeping an eye on the next data may be important to determine whether the monetary authority will reduce interest rates in next month’s meeting. Should economic data turn out feeble (as in the case of industrial production also released this week), the arguments for a further interest rate cut may gain steam.