MNI: Inflation Expectations Seen Key To Pace Of Brazil Easing

A fall in long-term inflation expectations closer to the center of the Central Bank of Brazil’s inflation target range would potentially allow an acceleration of interest-rate cuts, but former members of its board were divided over whether this is likely in comments to MNI.

According to the BCB’s Focus market survey, expectations are at 3.5% for 2025, 2026, and 2027, too high for comfort versus the target of 3% plus or minus 1.5% set for it by the National Monetary Council. The inflation implied by Brazilian government bond yields is even higher, at around 4.3% a year until 2027.

While central bank officials frequently express concern over inflation expectations, with Deputy Governor of Economic Policy Diogo Guillen saying on Wednesday that restrictive policy settings remained necessary, some policy makers are optimistic they will decline if actual inflation continues to ease. This would potentially give the BCB’s monetary policy committee Copom room to cut rates more aggressively. Inflation dropped to 4.62% in December, after peaking at 12.13% in April 2022.

The BCB’s former deputy governor for international affairs,Tony Volpon, sees such a benign scenario as probable, saying that market pricing will shift as inflation data comes in lower.

50-BASIS-POINT PACE

For the moment, the pace of reduction in the official Selic rate, which is now at 11.75% after four consecutive cuts from its 13.75% peak, is consistent with the rate of improvement in inflation, said Volpon, now a professor at Georgetown University. The BCB should avoid maintaining policy at more than necessarily restrictive levels, he added, pointing to 2016 when it kept the Selic rate high despite sliding inflation. (See MNI POLICY: Brazil's Copom Sticks To 50BP Cuts As Doves Fly)

"The Copom only cut interest rates in October of that year when expectations reanchored, and inflation fell below the target floor in 2017, resulting in overtightening," Volpon said.

For the moment, inflation expectations are being boosted by fears that Brazil’s left-of-center government will lose fiscal discipline, and over a potential dovish shift in the BCB following the conclusion of the term of Governor Roberto Campos Neto at the end of this year, he said.

“It’s natural for there to be a premium,” he said.

FISCAL CONCERNS

However another former Copom member, Fabio Kanczuk, who was deputy governor for economic policy until 2021 under Campos Neto, was less optimistic.

"I think it would be strange if inflation expectations were anchored. Inflation is still well above the target, and the central bank is cutting interest rates. Even without a change in the Copom's reaction function, I think more effort or luck is required to anchor them again," said Kanczuk, who is now a director at ASA Investments.

For Kanczuk, expectations are likely to remain stable, but will only be reduced with an improved fiscal scenario or tighter monetary policy.

"I think they will only unanchor more if inflation starts to rise significantly again and the central bank does not react," he said. But he added: "Since President Luiz Inacio Lula da Silva doesn't want to improve fiscal policy, the central bank will have to adopt a tougher stance in monetary policy.”

Copom next meets on Jan 31.