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Brazil - Economic Briefing February 2003

Currency and Inflation Concerns Prompt Further Monetary Tightening

Continued concerns about currency weakness and resulting inflationary pressures prompted the Central Bank to raise the benchmark interest rate for the fourth consecutive month. However, to avoid choking off the economy with an ever tighter monetary policy the new Central Bank administration decided to raise its inflation target allowing for a more accommodative stance.

Inflation gaining speed as currency stabilizes but concerns loom
In January, the National Statistical Office (IBGE) reported that the mid-January consumer price index (IBGE-IPCA 15), which covers monthly price increases up to the 15th of every month, rose 1.98% over December. The January data came in well below the 3.05% monthly increase observed in December. Nevertheless, the annual inflation rate continued to rise from 11.7% in December to 13.2% in January. Last year’s currency weakening and rising oil prices have exerted substantial upward pressure on prices in the past months. As a result, the Central Bank decided to raise this year’s annual inflation target to 8.5%, up from the 4% target previously. In addition, monetary officials revised the inflation objective for 2004 from the previous 3.75% to 5.5%. The hike in the inflation targets was largely anticipated since the new Central Bank president, Henrique Meirelles, who was appointed by Lula, had already indicated that reaching the previous inflation targets was overly ambitious and reaching the targets would require a monetary policy too tight under the current economic slump. But even the lowered targets seem ambitious. Currently, the annual inflation rate remains well above Central Bank target for this year and the Consensus does not expect the Central Bank to meet its target, with consumer prices anticipated to rise at a much more pronounced 11.2% pace this year. Similarly, at 8.1%, next year’s inflation rate is seen significantly above monetary officials’ objective. Consequently, monetary authorities are unlikely to have significant leeway to lower interest rates significantly in the near future. Consensus Forecast participants had already factored last year’s currency shocks into their inflation forecasts. The recent currency stability, if persistent, could favour an improved inflation scenario for this year. Since the elections in October - which had brought the real close to the 4.00 reais to the US$ threshold – the real has strengthened significantly, appreciating four consecutive months and strengthening by 12.2% to the US$ compared to its weakest level on 22 October. In January, the currency appreciated again – by 0.2% - over the prior month. However, the strengthening was more modest than the 2.9% rate observed in December, as investors continue to evaluate the new administration’s economic policy and governance prospects. The real strengthening abated further in early February, as concerns over the stability of the governing coalition in Congress raised additional fears about economic policymaking under the Lula administration. Nevertheless, the recent stability in the currency appears to have infused panellists with heightened optimism about the strength of the real this year, as the Consensus now expects the currency to end the year at 3.60 reais to the US$, which would represent a 1.9% annual depreciation only over 2002. The forecast for 2004 sees the currency depreciating at a more pronounced 8.0%, closing at 3.96 reais to the US$ by year-end.

Central bank hikes interest rates for fourth consecutive month
On its 22 January meeting, the Central Bank decided to raise the benchmark SELIC rate from 25% to 25.5% - the fourth consecutive monthly hike. Monetary authorities justified the tightening with continued concerns about lingering inflationary pressures and uncertainty regarding the exchange rate in light of a possible conflict in Iraq. Participants have revised their interest rate forecast again this month, anticipating the SELIC rate to drop moderately to 19.7% by the end of this year, which is 0.4 percentage points above last month. In fact, panellists anticipate the Central Bank to be able to lower rates within the first quarter of this year if currency uncertainty subsides. Furthermore, the easing of inflationary pressures will lower interest rate further next year to 16.3%.


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Note:  The above text is an abridged version of the LatinFocus Consensus Forecast country briefing.  For more details please click here.



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