Brazil - Economic Briefing July 2004

Looming Inflation Risks Threaten to Derail Recovery Looms (continued)

Inflation up amid rising fuel and food costs
In June, consumer prices rose 0.71%, which was up notably from the 0.51% increase observed in May and was also well ahead of market expectations.  The persistence of higher monthly increases observed over the past couple of months reflects rising food costs (+0.72%) resulting from adverse climate conditions.  In addition, the winter season drove up clothing prices (+1.14%), while higher fuel prices prompted a notable spike (+1.58%) in transportation prices.  As a result of the June reading, the annual inflation rate increased from 5.2% in May to 6.1%.  Producer prices have been exhibiting a similar rising trend.  In June, producer price rose 1.57%, which was down moderately from the 1.71% observed in May but continued a trend of high monthly increases in excess of 1% observed since February.  Furthermore, as a result of the June producer price reading the annual variation rose to 11.8% from 8.8% in May.  At its current level, the annual variation in consumer prices is well ahead of the 5.5% central inflation target set by the Central Bank for this year but falls within the tolerance interval of +/-2.5%.  In its quarterly inflation report released on 30 June, the monetary authority revised its inflation forecast for this year upward from 5.2% to 6.4%, citing higher than anticipated fuel, food and utility (telephone and electricity) price increases.  Furthermore, authorities confirmed the 4.5% inflation target for next year (with a +/-2.5% tolerance margin) and announced that the same target and tolerance interval would be maintained for 2006.  The Central Bank’s current target level for this year is well below the Consensus Forecast estimate of 6.7% - revised upward 0.2 percentage points.  Inflation is anticipated to moderate next year to 5.7%, which is more than one percentage point above monetary authorities’ official target but still remains within the tolerance interval.

Central Bank postpones further monetary policy easing
Concerns about rising inflationary pressures, particularly from fuel and food prices, along with the acceleration in economic activity, prompted the Central Bank to maintain the benchmark SELIC interest rate unchanged at 16.0%.  The 16 June decision was consistent with a more cautious monetary policy observed since the beginning of the year, when Central Bank officials decided to halt more aggressive interest rate cuts, which had brought the SELIC rate down 8 percentage points from July 2003 to 16.5% by the end of last year.  So far this year, a combination of higher economic activity, more adverse international markets and rising oil prices have prompted monetary authorities to adopt a more cautious stance on monetary policy rather than implement further aggressive cuts to bolster the economic recovery.  Nevertheless, Consensus Forecast participants expect the Central Bank to ease rates further to 14.9% by the end of this year but have adjusted this year’s SELIC interest rate forecast upward by 0.3 percentage points from last month.  An easing of inflationary pressures next year is seen as providing the Central Bank with additional leeway to ease monetary policy, as the SELIC interest rate is expected to drop to 13.3%, which is up 0.3 percentage points from last month.