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Brazil monetary policy: State of stagflation?

 

Prior to the 3rd June SELIC decision we were of the view that July's meeting would likely mark the end of Brazil's tightening cycle with a 25bp hike to 14.00%. The statement that accompanied the June decision caused us to question that call as it was very similar to the statement issued alongside the previous statement. As such, expectation was pushed back to the 2nd September and penciled in another 50bp hike for the July meeting.

"Since the last meeting, with the exception of May's industrial production print (+0.6% m/m, -0.4% y/y, cons. -0.4%, -10.0%) just about every Brazilian macro data release has pointed to a further deterioration. Activity continues to disappoint in just about every section of the economy and every single measure of inflation has pointed to continued rising price pressures. Although this is not a new development, Brazil is in a state of stagflation and for the remainder of this year that dynamic is only likely to worsen", says Rabobank.

Forecast for inflation now shows IPCA printing above 9% 2015 with an end of year rate of 9.2% y/y before heading lower next year. It is noted that, the Bank is focusing closely on price pressures and is taking action to bolster its credibility as an inflation targeting central bank. This is particularly important at the moment as stagflation always raises question marks about how a central bank will react but the Bank has been clear that price pressures remain the focus. Indeed, Deputy Awazu stated that "Monetary policy's best contribution for Brazil's growth prospect is to help, by bringing inflation to the target and anchoring it, the consolidation of a stable and favorable macroeconomic scenario in longer term horizons."

Awazu stated that "The BCB also has anchored inflation expectations in medium-term horizons, in 2017, 2018 and 2019, right on 4,5% p.a. target." The latest Focus survey showed expectations for 2015 rising from 9.12% to 9.15% but looking to next year expectations were revised lower for the third consecutive week and now stand at 5.4%, while inflation is expected at just 10bp over the 4.5% target in 2017. It is viewed that, this partly reflects confidence in the central bank's actions and the renewed confidence in the Bank's inflation fighting credentials are one of the drivers behind call for another 75bp of tightening this cycle.

In terms of activity, it is expected that, the economy to contract 1.7% y/y in 2015 and grow 0.3% y/y in 2016 but would go a step further and suggest that this would likely be a best case scenario for Brazil. Indeed, the risk of a 2 handle contraction this year and a second year of recession next year is significant and could easily come to fruition - the risk is firmly skewed to the downside. Slowing growth has been accompanied by a rapid deterioration in the Brazilian labor market. June's data revealed that, at 6.90%, the unemployment rate is now a full 2.1ppt higher than it was in June of last year and is at highs not seen since 2010.

Rapidly diminishing support for the government Dilma's approval rating has fallen to 7.7% and political stress are likely to weigh on broad economic policy and a marginal shift to a slightly less hawkish stance in central bank rhetoric has been observed in last few weeks. The worsening growth picture poses an increased risk to Brazil's fiscal footing as well. FinMin Levy recently announced a downward revision to the primary surplus target from 1.2% in 2015 to 0.15% while 2016 is seen at 0.7%, 2017 at 1.3%, and 2018 at 2.0% - so effectively Brazil has pushed back its 1.2% goal by two years. That the target has been revised down will come as little surprise to Brazil, notes Rabobank.

 

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