Strengthening of Brazil’s currency following the election of Jair Bolsonaro as president on 28 October, together with lower expectations for regulated prices, means we have reduced our inflation forecasts for 2019 and 2020.
A meeting of the central bank’s interest-setting committee immediately after the election concluded that domestic risks to Brazil’s reform have diminished. That makes us think that instead of raising rates by half a percentage point before 2019, the bank will hold them at 6.5 per cent, then announce a quarter-point increase next February.
Brazil’s final pre-election inflation figures showed that the upward rebound in price rises has lost some steam. Annual inflation for regulated prices fell from 10.38 per cent to 9.91 per cent thanks to cheaper petrol and diesel and a marginal decline in electricity charges – though the continuing drought still threatens future increases. With large increases in administered prices less likely, they no longer pose a major inflation threat.
Freely-determined price inflation rebounded from 2.58 per cent to 2.76 per cent but remains firmly under 3 per cent, representing a recovery from the strong disinflation of 2017, not a fresh inflationary impulse.
This suggests that inflation pressure is receding, and although we have raised our 2018 forecast slightly, from 4.2 per cent to 4.3 per cent, our 2019 projection has been revised down from 4.8 per cent to 4.5 per cent, with 2020 cut from 5.3 per cent to 4.4 per cent.
The central bank raised its own forecasts to 4.4 per cent for 2018 and 4.2 per cent for 2019 but kept expectations at 4.0 per cent for 2020 and 3.9 per cent for 2021. However, these projections assume the key interest rate rises from 6.50 per cent to 8.0 per cent during 2019. We think the increase will be to only 7.5 per cent.
The post-election interest-rate committee discussed the removal of policy stimulus for the first time. The withdrawal will be gradual but is likely within a year. That leads us to delay moving the beginning of normalisation with interest rates remaining unchanged until February 2019.
However, Brazil’s previous president changed the basis for setting the rate used for subsidised long-term loans from state-owned banks. It now relates to bond yields rather than being determined by the National Monetary Council and the implied subsidy has fallen below zero.
We think the central bank now has much more power against inflation because it does not have to compensate for an extremely low subsidised rate. We are thus keeping our forecast at 7.50 per cent for the end of 2019, not 8.0 per cent. And the reduction in subsidised credit means it can be returned to 6.5 per cent in 2020.
The heightened worry about the external environment has not changed, with continued worries about the effects of rising US interest rates and increasing trade tensions. But better sentiment following the election, combined with significant excess capacity, should weigh against any secondary inflationary effects.
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