Brazil - Economic Briefing May 2004

Economy on Slow Recovery Path but Favourable Monetary Setting to Help (continued)

Inflation moderating further aided by stronger exchange rate
The national consumer price index (IBGE-IPCA) increased 0.37% in April.  The April figure came in below the 0.47% monthly increase observed in March and was well below market expectations of 0.51%.  As a result of the moderate increase, the annual inflation rate dropped from 5.9% in March to 5.3% in April – the lowest rate observed in more than four years.  Seasonal factors had provided a notable upward push to consumer prices in the first three months of the year.  However, the price pressures associated with the beginning of the new school year and the declining food stocks in light of the inter-harvest period appear to have abated.  Consensus Forecast panellists expect the anticipated pickup in economic activity this year and increased currency depreciation to exert upward pressure on prices.  In fact, foreign currency markets remain the key determinant of continued price stability.  In the short term, the currency is likely to experience some volatility.  Market jitters about the increased likelihood of a tightening of monetary policy by the U.S. Federal Reserve prompted the currency to depreciate 1.5% in April in nominal terms versus the US$.  The April weakening had the currency closing at 2.95 reais to the US$ by the end of April – 2.1% weaker than at the end of last year.  Despite the possible upside pressure on prices resulting from the currency depreciation and heightened economic activity, Consensus Forecast panellists believe that inflation will rise only a notch from current levels to reach 6.2% by the end of the year, which is 0.1 percentage point above last month’s Consensus Forecast figure.  The current Consensus estimate is still ahead of the Central Bank’s central target rate of 5.5% but is within the +/- 2.5% tolerance margin.  Furthermore, the Consensus Forecast figure for next year is 5.2%, which is also well in excess of the Central Bank objective of 4.5% but within the +/- 2.5% tolerance margin.  

Central Bank eases further amid more favourable inflation setting
In its 14 April meeting, the monetary policy committee of the Central Bank (COPOM) decided to lower the benchmark SELIC interest rate from 16.25% to 16.00%.  The April move resumed the easing trend observed since March last year, which was only briefly interrupted in January and February and has brought the SELIC rate to its lowest level observed in two years.  Central Bank authorities believe that inflationary pressures observed earlier this year have subsided and that in the coming months price increases will moderate further.  Furthermore, monetary officials believe that increased prospects for an interest rate hike in the United States are unlikely to have a detrimental impact on foreign exchange markets, as markets have already incorporated the shift into asset prices already.  As a result, the pass-through of a weaker exchange rate to domestic prices is seen as limited.  In addition, Central Bank authorities are confident in the government’s fiscal policy continuity.  Consensus Forecast participants share the Central Bank’s confidence that consumer price increases will remain contained and anticipate that the more propitious inflationary setting will provide the conditions for further monetary easing this year.  In fact, Consensus Forecast participants see the SELIC rate dropping further to reach 14.2% by year-end.  Furthermore, the lower inflation trend is seen as carrying over into next year and will prompt monetary officials to lower the benchmark interest rate further to 12.9%.