Question of the week: Will inflation continue to rebound in Brazil in the near term?
A: Temporary shocks related to the pandemic have been pushing inflation higher in Brazil in recent months, continuing to sound alarms, and questioning the COPOM's current policy bias. Data released this week showed that Brazil's unadjusted mid-month Consumer Price Index, the IPCA-15, rose 0.8% month-to-month in November, above expectations for a third consecutive month. The sharp gain, which was the biggest for November since 2015, was driven by price increases in all nine components, with food and transportation the main drivers. The year-over-year rate rose to 4.2%, the highest rate since January, and up from 3.5% in October.
Widespread scarcity, logistic bottlenecks, low inventories—as many companies ran down their stocks during the lockdown—and high input prices as the economy resumes activities, following the toughest phase of isolation, all have helped to trigger temporary inflation pressures. Moreover, the gradual reopening of the economy is prompting upside forces in key components, particularly services, and the effect of monetary and fiscal stimulus has been pushing goods prices higher in recent months. Rising food prices, due to higher global demand, and the lagged effect of the FX depreciation during Q3, have also contributed to the recent inflation uptrend.
We still believe that the recent inflation rebound is temporary, and that November’s rebound is not the start of a protracted upward trend. Manufacturing output is on the mend, which will start to ease inflation pressures in the pipeline. Demand-related pressures, meanwhile, will remain tame over the next six months, as economic activity is still well below normal, key sectors remain under severe strain, and the end of the emergency aid program is approaching. Our base case is that inflation downside forces will prevail in the near term. Moreover, the pandemic remains a big threat.
Overall, inflation in Brazil has rebounded in recent months as the economy has reopened, and temporary shocks related to the pandemic have been more evident. Note that headline inflation will end the year at around 3.6%, thanks to favourable base effects, but this will be followed by a modest increase in Q1. The key story here is that inflation likely will remain under control over the next three-to-six months, but the recent performance of key inflation components has underscored that risks are now clearly tilted to the upside. We expect policymakers to keep interest rates on hold for the foreseeable future—albeit strengthening their cautious bias—assuming the BRL remains under control and the fiscal consolidation approach continues.
Senior International Economist